One way to make sense of the recent plummet in gold prices is to understand the differences between how institutional and individual investors approach gold.
When worsening economic data should have pushed gold higher, gold traded in a tight range instead. In 2015, reaching a high of $1,300 an ounce after news that the U.S. economy con-tracted earlier this year to a low of $1,150. With continued U.S. mixed data, worsening econom-ic data from China, and Greece technically defaulting on their IMF loan repayment, gold traded in a tighter range between $1,225 and $1,175 instead of increasing in price.
And when the economic news should have pulled gold lower, gold prices plunged 4% to the lowest level in five years. This came after Fed Chair Janet Yellen testified before Congress that interest rates would likely increase this year from the current zero interest rate policy. The other trigger was China’s announcement about their current gold reserve holdings, which were below speculators’ expectations.
Gold continues to sink today even though there is a fair amount economic uncertainty and risk. For example, the IMF recently downgraded their global economic forecast yet again, with con-cerns about the U.S. economy leading the way. China’s data continues to worsen except for this month’s outlier. Greece is on a rocky path toward another bailout, which if successful, only postpones their economic judgment day.
A key driver for this is institutional investor sentiment toward gold has remained very negative. There are a few possible causes. Certainly the inevitability of rising interest rates and a stronger dollar contributes to anti-gold sentiment. But they are also betting that governments can be effective containing economic crisis from spreading systemically. For example, Greece will like-ly get another bailout because it is too important for the EU/ECB to keep the euro intact. And the Fed will likely postpone raising rates if they believe the U.S. economy cannot handle it.
Individual investors are not so sanguine. While institutions have been staying away from gold, demand for physical gold is up now among individual investors. Sales of American Eagle gold bullion coins by the United States Mint skyrocketed 600%, from 21,550 ounces in May to 118,500 ounces in the first two weeks of July. Unlike institutions, individuals have less access to sophisticated financial instruments to hedge risk. They mostly do it the old fashion way though precious metals (the U.S. Mint also sold out of silver bullion and have temporarily suspended sales). But in the aggregate, they have less impact on gold prices than institutional investors.
The influence of these divergent approaches may be reversed in the future. Institutional inves-tors dominate the western hemisphere but individual investors dominate the eastern hemisphere. While western institutional investors remain sour on gold, eastern individual investors are buying lots of physical gold, though until recently, not at the same record pace.
That is because India and China are creating huge numbers of new middle class who have a cultural affinity for diversifying their wealth into physical gold. And expect India to buy more physical gold because of the recent relaxing of government restrictions on gold importation. It will regain its crown of the top purchaser of physical gold in the world.
China has taken additional measures. While there was disappointment that China “only” in-creased their gold reserves by 65%, it was enough for China to move up to 6th place in the world, leapfrogging over Russia (no slouch in adding to national gold reserves). China also has established their own gold exchanges and hope to get IMF approval for the yuan to be included as a reserve currency. China envisions a future where the global economy (and gold) less dominated by the west and the U.S. dollar.
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