What Happened to Gold in 2008?

The last year in gold reviewed – plus the outlook for Gold in 2009...

THE GOLD MARKET began 2008 with a normal bull market pullback from its highs of $1,035 to the very low $900 level, notes Julian Phillips for the GoldForecaster.com.

Jewelry had already begun to recover as the Gold Price dropped, but then the impact of the "investor meltdown" –through forced selling by leveraged investors such as hedge funds, selling what they could to cover losses in other markets – hit gold too.

To make matters worse, in the United States so many investors had paid from only a 10% deposit up to a 50% deposit on the shares they owned. So when these share prices dropped more than 10% to 50% investors lost 100% of their capital. This type of selling sent prices lower, in the course of which more selling was triggered by the system of "stop losses", which automatically send out an order to close the position, without needing to contact the investor.

Consequently, although the gold market fundamentals looked excellent, the investor's struggle for survival, made them sell even their gold and silver positions. As a result the price of Gold Bullion was sent on a downward slope until it bottomed at $690 an ounce.

The percentage fall in Gold Prices was far less than other markets saw, however, whether equities or commodities. Investors capable of paying in full for their investments took to the sidelines waiting for the investor carnage to stop. It seems that they are cautiously entering certain markets now, including the gold market. Consequently in a thin, sold out market, it takes little to make prices move a long way.

The rise from $690 to the present level of $870 took place in two stages, as bad news for the global economy brought gold investors back to the market place. It has pulled back since breaking out and could sink as low as the very low $800, without disturbing this pattern. Alongside this there is a perceptible change of mood in the market. The trauma of 2008 with its systemic failures and disillusion is calming.

Investors are not staring into the abyss quite as much, even though there could still be good reason to do so still. For now, however, it seems that because the expectation is for more bad news, attitudes are changing from despair to acceptance, to the search for solutions.

So 2008 was to us the year of "Investor Meltdown" and a reshaping of both investor competence and appetite. The main feature of the year was something we have been forecasting for years that is the system of "Live now, pay later" just could not go on and had to collapse. 2008 saw governments facing systemic failures in the banking system, spreading out to capture all financial markets. Confidence and trust in the banking system has eroded almost completely, not only between customer and bank, but also between bankers themselves. Like slowing blood in the human body the whole economy is now threatened. As a result the global economy has nose-dived into a deep recession.

What of Gold in 2009 amid this scene? Gold does well in deflation as cash grows in value as asset values drop, through fear and distrust in the system. And with the "investor meltdown" in full swing during 2008, markets that were not functioning well fell against what appeared to be excellent fundamentals. Likewise gold continued to point downwards. But then after touching $690, street-smart investors started to pick up gold "on-the-dips".

Then, after rising above $800 the gold price turned back down as more bad financial news hit markets and industry and retailing. All investors then felt the effects of the damming of liquidity in the banking system. Deflation had arrived, or at least investor's perceptions of it had, and markets fell again, but gold broke away and started to do better. After all it had only fallen 25% compared to considerably larger falls in other markets.

The US Dollar, which had in the last couple of years moved in the opposite direction to Gold Investment prices, began to strengthen in the year as the "carry trade" (borrowing cheaply in the United States or Japan and lending overseas into high-interest paying nations) found itself squeezed badly as the process of "de-leveraging" began in earnest across the board.

This caused the Dollar to rise from a low of $1.60 to the Euro to around $1.23 to the Euro. But the reality was that the rise of the Dollar was a defensive action and not based on anything that should have given a good cause for the US currency to rise. All in, the markets are fully aware that the "reflationary" acts by central banks and governments in the developed world give a very good cause for a weakening of the Dollar.

As 2008 comes to an end, the Dollar has weakened sharply and fallen from $1.26 to $1.41 by Christmas, an extremely dramatic decline in so short a period. It is presently clinging to a level just above $1.40 at $1.3990 as we write. Gold, in turn, has shrugged off its downward path and now looks to want to challenge $900+, even though it pulled back to $830.

So the outlook for Gold in 2009...? Under the sage eye of Mr. Ben Bernanke, the Fed's battle against deflation has taken the form of resuscitating the blood flow of the economy through saving the banks (not effective because they are now sitting on this new money and not lending into the economy, as they were expected to and hoping to save themselves), then through a more direct approach, he is flooding the system with money through "Quantitative Easing". These reflationary policies could have an explosive effect of inflation. Clearly he hopes to suck out that excess liquidity by selling the very instruments he bought with newly printed money. But will the markets then buy them? Remember confidence was shattered in 2008.

Central banks across the world have acted in concert to lower interest rates to similar levels to each other taking them down to such low levels that in themselves they are stimulating their economies. With interest rates tumbling across the globe, the world's central bankers are acting in concert, clearly in the hope that foreign exchange rates will stabilize.

At the same time, the global economy and the nations that make it up are all stimulating their economies. The Swedish central bank, Bank of England, and the European Central Bank cut short-term interest rates by 1.75% to 2%, 1% to 2%, and 0.75% to 2.5%, respectively of late, with Japan and the States just about at zero and, without a doubt, more cuts to come, from anyone out of line.

Add to this the monetary stimulation, through direct injections into the money system, alongside "quantitative easing" (flooding the system with liquidity directly) that we are now seeing across the developed world, and you end up with a tidal wave of reflation that hopefully will effectively tackle deflation. On the dark side, this wind of reflation will become a global whirlwind of inflation. Of course as deflation turns to inflation the speed with which money is spent increases rapidly assisting inflation to rise higher. Money cheapens and assets rise in price. In the event that this does in fact take place, will all be well again? Unfortunately, the answer is no and we firmly believe that the Central Bankers are fully aware of this. The fundamentals of the gold market could not be better!

We are seeing investors in India and the gold producing nations gaining the benefit of a rising gold price even as the gold price holds still or falls, because their own currencies are losing value, showing just how good gold is in a weakening currency. This is physical demand and remains strong from the East side of the world. Even stronger is the physical demand for small bars and coins in Europe and the States. So strong is that demand that the coin producing mints and refineries are way behind on deliveries and working 24-hours a day. What is rapidly becoming an investor belief is that gold is an answer in all the scenes that could unfold in 2009.

As if to confirm the safe-haven nature of gold the volatility seen in 2008 will grow without restraint in 2009. This is just how loss of confidence and its replacement by uncertainty and fear, expresses itself.

What should investors expect of Gold in 2009? Reflationary policies are only a lifeboat in the stormy seas, not a real calming of the storm. This won't happen! Not until the reformation produces a financial system on which all can firmly rely. That is not even being discussed. You can be sure that any reformation will not move away from our current structures. So brace yourselves for more of what we've seen already in different places and in different guises in different markets. This can only benefit the gold markets as more and more investors realize just why it has had such an important place in the history of money.

Inflation will be with us and accelerate until it has conquered deflation and restored economic confidence to former levels. We cannot foresee that happening with the people, tools, and plans being used to patch up the global economy, so far. So gold will confirm the resumption of its long-term upward trend. The gold market fundamentals will affect the price in an upward direction as production of gold continues to hold or fall, while investment demand will grow substantially.

Central banks are slowing the sale of their gold to a trickle, so we would be surprised to see total sales for this year more than 150 tonnes, an amount that will not affect the gold price at all. But imperceptibly and certainly not for publication, central bankers are weighing up the benefits of their present policy of building confidence in currencies through gold sales. In fact currencies have not and will not benefit from such sales any longer. As Prime Minister of Britain, Gordon Brown has and is experiencing, sales and talk of future sales of gold simply undermine the credibility of politicians and central bankers in the face of the growing popularity of gold and falling confidence in currencies. But most important of all is the clear signal now being seen that the prospects of stability, of effective monetary reform or of systemic health is fast disappearing, leaving us with volatility, fear and doubt, in the future. The reliability of 'normal' investments is fast diminishing. The attraction of the obligation-free, nationality-free and global acceptability of gold will create a vibrant, rising market for gold and with it, following behind, gold shares.

Gold shares are tied to the uncertainties of corporate risk, but gain in profitability far more than the gold price in percentage terms when the gold price rises. They have lost attraction over the last two years as investors favored the gold Exchange Traded Funds (ETFs) where there is only a risk on the gold price, albeit without the reassurances of outright ownership and physical control. However, the returns on some gold shares are now extremely attractive because their prices have fallen so far.

All in all, we believe that 2009 will prove to be one of the most exciting years for gold that we will ever see! "Gold is always accepted and is the ultimate means of payment," as Alan Greenspan testified before Congress almost ten years ago – on May 20, 1999 – "and is perceived to be an element of stability in the currency and in the ultimate value of the currency and that historically has always been the reason why governments hold gold."