Drop in Gold Price: A Plan for Another Round of Quantitative Easing?

Sumanasiri Liyanage

From The Hindu

After April 2012 drop in gold prices, global gold market has registered a sharp drop in prices once again in April 2013, just before the Sinhala Tamil New Year. The spot gold price hit an intraday low of $1,493.35 (£972.40) per troy ounce, putting it 22.3 per cent below September 2011's intraday peak of $1,921.41. Thus gold posted its biggest weekly decline since December, 2011. A bear market is loosely defined as a 20pc fall from its high. Although prices recovered to $1,505.20, the precious metal is still trading 21.7pc below its peak. "The scale of the decline has been absolutely breathtaking. We tried to rally and that just didn't get anywhere ... there hasn't been any downside support, it's like a knife through butter," Societe Generale analyst Robin Bhar said. Parallel to this developments, gold prices became bearish in Mumbai billion exchange prices of gold falling from 30200 Indian rupees per 10 grams on April 1, 2013 to 28350 Indian rupees on April 13, 2013. This is a 15 per cent decline in two weeks. According to Hindu, Suresh Hundia, President-Emeritus, Bombay Bullion Association (BBA), said: “It is huge fall in price and it follows global developments. There has been overall selling globally by banks and exchange traded funds (ETFs).” Hundia added: “Internationally, investors have been pulling out of gold and opting for property, equity and fixed deposits where the interest rates have improved. In India, over the next few weeks, price could dip to even as low as Rs. 27,000 per 10 gram levels by month-end,” Mr. Hundia said. Further decline of gold prices internationally has been predicted. "Could it retest USD 1,300 or USD 1,200 on a short-term technical basis? Absolutely yes," said Geoffrey Fila, associate portfolio manager at Galtere Ltd, a commodities-focused hedge fund in New York.

How do we explain this drop in gold prices? Is it possible to accept the conventional explanations by so-called market experts? Or should we go beyond that? In this article, I intend to dig into deep roots of these developments as they may be related to the financial and economic crisis of 2008 from which the world economy has not yet recovered. Let me at the outset explain the role and the place of gold in international financial architecture. In Marxian economic theory, in strict sense, the concept of the ‘price of gold’ is meaningless. The price of a commodity is precisely its expression in the value of gold, the ‘price of gold’ would be thus the expression of the value of gold in the value of gold. The value of gold may decline if the productivity of mine workers in gold mines registers an increase. Similarly, the value of gold may increase if the cost of production in new mines is higher than that of old mines. Here, when we talk about the ‘price of gold’ we really mean the price of gold in paper currencies i.e., dollars, pounds, Indian rupees and so on since paper currencies are supposed to be backed either formally or informally by gold. Since the bulk of the gold stock as well new production are used as the basis of money supply even in formal or informal way, the price of gold used in industrial production is also determined by the its unit of account function. Hence, price of gold in national currencies vary with the supply of national currencies in circulation. If more dollars are issued by the Federal Reserve System (FRS), price of gold would increase and vice versa. Gold prices began to increase in 2011 reaching $1,917.50 a troy ounce on August 23, 2011, as a consequence of quantitative easing policies adopted by the FRS in response to financial crisis in 2008 that was followed by a severe economic downturn in almost all major economies.  Gold price registered an increase for more than a decade due to its status as a safe-haven investment in troubled times and in response to inflation fears as the Federal Reserve embarked on an aggressive stimulus program to jump-start the US economy after the financial crisis in 2008.

   

The drop of price of gold has been attributed by market analysts for three factors. Mike van Dulken, head of research at Accendo Markets, said gold had suffered a "three pronged attack" from a stronger US dollar on the back of speculation that the US Federal Reserve could end quantitative easing by 2014, news that Cyprus would sell its gold reserves, and recent bearish sentiment from analysts.  Some of these explanations are problematic. There has been no indication yet that the world economy would recover soon after the first depression of the 21^st century. US retail data has registered unexpected contraction that may help dollar immediately but would affect adversely the recovery in the long run. It is true that Euro Zone crisis has already forced Cyprus to sell its gold reserves to raise around 400 million euros .  However, Cyprus' gold sale in itself is small and may not make a big impact on world gold prices as the emerging nations like China, Russia and India are planning to increase their gold reserves. Cyprus crisis would catapult further crisis in the Euro Zone as heavily indebted euro zone nations such as Slovenia, Hungary, Spain, Italy and Portugal could also find themselves under increasing pressure to put their bullion reserves to work. The increase in supply of gold in that way may result in further decline in gold prices.  

Is Gold Price Manipulated?

It is interesting to note that the continuous increase in the price of gold in the last two years or so has generated anxiety among policy makers in the US for multiple reasons. Since there is no clear sigh of strong recovery even in the US economy, it is hard to believe that people would move away from gold to acquire dollars the value of which has been declining. The decline of the value of dollar can be attributed to many reasons some of which are outside the sphere of economy. The Federal Reserve’s policy of printing $1 trillion annually in order to support the impaired balance sheets of banks and to finance the federal deficit was the major reason. The US cannot afford to finance the long and numerous wars that the neoconservatives were engineering. Quantitative easing and low interest rates have threatened the value of dollar in terms of the standard money commodity, i.e., gold that has universal recognition. Dr. Paul Craig Roberts explanation seems to be interesting. He has argued that in spite of Bernanke’s recent remark that the US FRS may not resort hereafter for quantitative easing, the FRS would go for printing of another 1 trillion dollars. Nonetheless, such increase in dollar supply may be difficult if the confidence in dollar’s value is at stake. He notes: “The Federal Reserve was concerned that large holders of US dollars, such as the central banks of China and Japan and the OPEC sovereign investment funds, might join the flight of individual investors away from the US dollar, thus ending in the fall of the dollar’s foreign exchange value and thus collapse in US bond and stock prices”. It is true for their own selfish reasons, central banks do not respond quickly. Dr. Roberts informed: “Central banks are slower to act. Saudi Arabia and the oil emirates are dependent on US protection and do not want to anger their protector. Japan is a puppet state that is careful in its relationship with its master. China wanted to hold on to the American consumer market for as long as that market existed. It was individuals who began the exit from the US dollar”. Has the FRS manipulated world gold prices for the benefits of the US? Does it have power and influence to do it? Dr. Roberts has answered both questions in affirmative. I will quote his explanations below;

“The Federal Reserve used its dependent “banks too big to fail” to short the precious metals markets. By selling naked shorts in the paper bullion market against the rising demand for physical possession, the Federal Reserve was able to drive the price of gold down to $1,750 and keep it more or less capped there until recently, when a concerted effort on April 2-3, 2013, drove gold down to $1,557 and silver, which had approached $50 per ounce in 2011, down to $27.

The Federal Reserve began its April Fool’s assault on gold by sending the word to brokerage houses, which quickly went out to clients, that hedge funds and other large investors were going to unload their gold positions and that clients should get out of the precious metal market prior to these sales. As this inside information was the government’s own strategy, individuals cannot be prosecuted for acting on it. By this operation, the Federal Reserve, a totally corrupt entity, was able to combine individual flight with institutional flight. Bullion prices took a big hit, and bullishness departed from the gold and silver markets. The flow of dollars into bullion, which threatened to become a torrent, was stopped.

For now it seems that the Fed has succeeded in creating wariness among Americans about the virtues of gold and silver, and thus the Federal Reserve has extended the time that it can print money to keep the house of cards standing. This time could be short or it could last a couple of years.”

As a result, there was a bearish sentiments in the precious metal markets. Holdings of the largest fund, New York's SPDR Gold Trust GLD fell a further 2.1 tonnes, or 67,710 ounces on Thursday, after a 17-tonne outflow on Wednesday.

What Will Happen in the Future?

Will the attempt by the US FRS succeed? Yes, currency manipulations and speculation play a crucial role in financial and some commodity markets. If the US is in a position to stop its quantitative easing and if the US economy can register reasonably high growth rate, it may be stabilize for some time the value of dollar and global confidence of it. Already, unnecessary dollar reserves exist in the global economy and the amount does not reflect the existing weaknesses of the US economy and its de-industrialization. In such a situation the maintenance of the value of the dollar in terms of gold would be highly unlikely. The Russians and Chinese, whose central banks have more dollars than they any longer want, would immediately react by transforming their unwanted dollar stocks into gold getting the advantage of the lower price of gold in the international market. As Dr Roberts noted, the low dollar price for gold that the Federal Reserve has engineered would be seen as an opportunity that the Federal Reserve has given them to purchase gold at $350-$400 an ounce less than two years ago as a gift. Price of gold in the last instance as in any other commodity is determined by the value of labor embodied in it. However, we have to keep in mind, in the case of gold, the value depends on the amount of labor spent in production at worst condition and not at average condition. The price of gold in national currencies on the other hand depends on money supply. The US failed in the late 1960s to maintain the gold convertibility of dollar. Since then, the dollar price of gold has registered upward trend.

Enormous war expenditure, huge bonuses for financial sector managers, tax cuts for wealthy people make it imperative for the US to increase its money supply in spite of Bernanke’s statement. As Dr Roberts has shown “the Federal Reserve’s attack on bullion is an act of desperation that, when widely recognized, will doom its policy. The gold would hit back if the deep rooted crisis of the capitalist economy continues.

The writer is co-coordinator of Marx School, Colombo, Kandy and Negombo.

E,mail: sumane_l@yahoo.com