Gold, frequently seen as the quintessential safe haven and stable store of value, has shocked its devotees. In the past two and a half years, it plunged from a peak price of $1,900 an ounce in mid-2011 to about $1,300 by late 2013. For those who bought gold for safety, the loss is particularly galling, for over that same time, U.S. equities rose almost 40%.

The plunge, unsurprisingly, has raised a lot of questions about the role of gold in a portfolio.

Traditionally, gold has attracted investors as a hedge in troubled times. Perhaps because of its tangible character and the more or less fixed nature of the global supply, there is a sense that it can hold its value better than intangible assets such as stocks, bonds and derivatives, which offer only a paper promise of some future payoff. Whenever concerns rise about war, inflation, political upheaval or a drop in the foreign exchange value of the dollar, gold presents itself as the go-to asset.

Some argue that gold has a role even when investors have few specific concerns. Because, they claim, dangers lurk even in the best of times, these people argue that every portfolio should include a little gold, just in case.


As reasonable as all this sounds, gold investing in practice is much more complex and much less secure. The difficulty arises because investors in gold, like all investors, must deal with more than their own expectations. They must also account for the expectations of others and their impact on pricing. When responding to concerns about inflation or war or whatever, a potential buyer of gold must assess whether other gold investors have already bid up the price in response to those same concerns. If they have, a latecomer might buy in at an already elevated price. Then even if the expectations are accurate, the price of their gold holding, having already adjusted up in anticipation, will not rise any further. Or if reality turns out to be less problematic than feared, the price might even fall. Either way, the gold purchase would fail to play its desired role in the portfolio.

To get gold right then, the would-be investor must consider two things simultaneously: (1) Whether there is reason for the kinds of concerns that make people turn to gold, and (2) whether others have already reacted to those concerns. Because the price is so subject to swings in opinion, gold turns out to be as volatile as any other financial asset.

Such effects were clearly evident during gold's price slide after mid-2011. Prices clearly did not fall because investors suddenly became confident about the future. On the contrary, plenty of worries remained. The Fed continued to threaten future inflation by pouring liquidity on financial markets; Europe's fiscal-financial crisis persisted; the Middle East remained as unstable and dangerous as ever, and Washington remained dysfunctional.

But when in 2011 the price rose to $1,900 an ounce, investors may have decided that it had gotten ahead of the probabilities that these concerns would become a reality. So, those who in 2011 looked for stability or protection in gold got neither.

Now, even at today's price, the case for gold going forward is whether reality will intensify fears or cause them to wane. Probabilities suggest that the price will hold steady and possibly drop further.

Certainly, the Federal Reserve is unlikely to change policy enough to move the price of gold much. It would seem that a tapering in the flood of Fed-provided liquidity would relieve inflationary fears and allow the price of gold to fall.

But such a move is as likely to raise gold's price over fears about a shock to the economy as it is to drive it down over relief on the inflationary front. That, after all, is what happened when the Fed first proposed tapering last summer. Gold prices rose briefly from $1,250 an ounce to $1,400 an ounce, only to fall back almost entirely when it became apparent in September that the Fed wouldn't taper after all. A steady state for the Fed or a gradual rollback is then more likely to hold gold prices steady than do anything else.

For all the fuss made in Washington about the government shutdown and a fear of default, the markets appear never to have bought into the panic. To be sure, the prices of all assets, including gold, showed tremors with each twist in the debate, but there was neither a concentrated flight from risk assets nor a concentrated rush to the presumed security of gold.

A firm budget compromise would surely relieve much fiscal anxiety and push the price of gold down. But a grand bargain is hardly likely.

Prospects for the economy, too, promise relative stability. A growth acceleration would, no doubt, lead to a drop in gold's price by relieving fears about defaults and government finances.

At the same time, a relapse into recession, which otherwise would raise anxieties about the future and so raise the price of gold, is unlikely. Housing, though hardly booming, is expanding, as are real estate prices. The economy has never gone into recession in the face of a real estate expansion, even a modest one.

Corporations are flush with cash, and though they are likely to remain cautious, they clearly face none of the financial squeeze that typically leads to cutbacks and recession. Households, meanwhile, have improved their finances, reducing debt levels to a point that, along with the admittedly slow but nonetheless positive expansion in payrolls, should sustain enough consumer spending to keep the economy out of recession.


Similarly, the outlook in Europe and on the currency front look balanced. There is little or no chance that Europe will drastically reduce gold's price by finding a way out of its fiscal and financial mess any time soon. Policy change simply is not moving fast enough.

But at the same time, little suggests much further deterioration. The European Central Bank shows a clear commitment to alleviating the situation, and Berlin, especially in light of the September elections, seems determined to avoid a breakup of the currency union.

Meanwhile, on the currency front, if the European situation remains in its current, admittedly subpar, state, so too the dollar-euro exchange rate is not likely to lurch in a way that might upset the gold-pricing equation. For the yen, the likelihood is for modest further dollar appreciation, which by itself would tend to reduce gold's price, though hardly enough to form a new trend. Nor would expected modest dollar depreciation against emerging market currencies offer enough of a move to change gold-price trends.

To be sure, central banks are likely to continue to buy gold, as will individuals in South Asia, the Far East and the United States in response to considerable hawking on television and online. But such flows are insufficient in themselves to drive up gold prices from current levels.

Geopolitics, as ever, remains a wild card. No doubt, direct action by the United States in Syria would have put upward pressure on the price of gold by threatening a wider war. To that extent, the current Russian "solution," dubious as it is to ensure the dismantling of Syria's chemical weapons, has tended to hold prices down.

The Iranian nuclear threat also remains. An Israeli or U.S. military strike would, of course, greatly intensify fears and cause gold's price to spike upward, perhaps even beyond the old highs. Though it is impossible to weigh odds on such an event, it is not unreasonable to proceed on the assumption that neither country is ready yet to make such a drastic move.

Short of such action, the Iranian tension has long had a presence in gold's pricing. To the extent that this latest round of negotiations makes progress, gold's price might well fall. If the diplomats just drift as they have to date, it would seem that little would have changed to affect the pricing of gold.

The risk that any one of these influences might intensify is undeniable. Much is unpredictable, and the price of gold hinges on many considerations. To declare, therefore, that prices will not rise would be foolhardy.

But it is still reasonable to conclude that the balance of probabilities points more to a further price decline or a leveling than to an increase. And it should be noted that stability is hardly attractive, since gold pays neither dividends nor interest.

Milton Ezrati is senior economist and market strategist for Lord, Abbett & Co. and an associate of the Center for the Study of Human Capital at the State University of New York at Buffalo.

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