As we pointed out yesterday the gold price has fallen approximately 40% from its highs of almost 2 years ago. The fall can probably be attributed to a combination of things, the weakening oil price, and a general reduction in the global fear factor, a subdued inflation outlook and lately the recent strength of the US dollar.
The traditional correlation of gold with the oil price is driven by the belief that many oil-exporting countries, for example the Middle East, traditionally like to invest in real assets and gold fits into that category. It therefore follows when the oil price falls demand for gold will fall. Demand gold is also related to jewellery demand, and according to the FT the Chinese in particular chased the first price setback last year and have been sitting on the sidelines this year.
What events could cause resurgence in the gold price? One would imagine an increase in geopolitical tensions, particularly in the Middle East, causing oil supply concerns would lead to a rise. Other causes could be an anticipation of a spike in global inflation, (this seems unlikely at present). A weakening US dollar may help the gold price raise, this is not necessarily the case as the fall in the gold price started before the rise in the dollar. Due to a historical link between gold and the US dollar during the time of the gold standard, gold is often seen as a hedge against the debasement of the dollar.
Gold is considered insurance in case of global uncertainties of inflation and geopolitical unrest in particular. The price of $1800 seems a long way away now. Despite the fall, the gold price has still trebled in the last 10 years, and is still 50% higher than what it was in 2008. Gold has so many potential drivers to its price, sentiment being one of the greatest, that it always seems hard to see where its true value lies. Gordon Brown thought its value lay around $250 an ounce. In the last 100 years the compound annual growth rate in the S&P 500 has been approximately 10%, gold has been roughly half that.
Looking back in the last 25 years the ratio of the gold price to the S&P 500 price has gone from a high of 1.4 to a low of 0.2 in 2000 at the height of the dotcom boom; currently it stands at about 0.6 which appears to be somewhere close to the mean for that period.