3Qs: Is the gold rush over?

On Monday, the price of gold plunged nearly 20 per­cent from its Sep­tember high. As the week con­tinued, gold rebounded a bit and began to climb again on better inter­na­tional eco­nomic news and increased demand. We asked Kamran Dad­khah, an asso­ciate pro­fessor in the Depart­ment of Eco­nomics who has studied the value of silver and gold in the for­eign exchange market, to dis­cuss what led to the plunge and how gold’s fate is tied to sev­eral inter­na­tional eco­nomic fac­tors.

Gold was valued at a record $1,900 an ounce earlier this month. What sparked the sudden plunge in the gold market?

The price of gold increased for two reasons: economic growth in China and India — which increased industrial, medical and ornamental demand for gold — and the fall in the value of the dollar. However, changes in the international economic landscape included a downward revision in the growth forecast for India and possibly China, and the strengthening of the dollar against the euro. Furthermore, the economic crisis in Europe has prompted speculation that there will be another recession in developed countries. It is expected that the revaluation of the dollar against the euro will continue because the European Central Bank is expected to lower its interest rate. That is a further reason to revise expectations regarding the price of gold.

Speculation that the price of gold would soon hit $2,400 an ounce created a rush to buy gold, which in turn created a mini-bubble, or a difference between the fundamental value of an asset and its market price. The speculative demand for an asset like gold is based on expectations — once facts on the ground change, expectations change, and if a bubble has been created it will burst.

On the supply side, many who lost money in the stock market turned to selling their gold to obtain liquidity. A combination of these factors changed the direction of the market.

How do developments in international economies affect the price and value of gold?

An increase in economic activity increases the demand for gold. Furthermore, the price of gold reflects the value of the dollar. Expectation of inflation prompts people to safeguard the value of their money by moving it into “safe” assets, that is, assets that have intrinsic values such as precious metals and real estate.

Gold rebounded a bit after hitting its low on Monday. Do you think it will recover to its former highs?

The gold bubble is deflated, and barring unforeseen catastrophic events, we would not see an immediate return to pre-plummet price levels. But we could expect the gold price to resume a slow and sustained increase over the next two years. There will be periods of no change or decline, but the overall trend will be upward. This is based on the assumption that there will be no catastrophic event or a crisis such as a full-fledged war in the Middle East. Such events will add to the uncertainty prevailing in financial markets today or increase the price of oil drastically. Under such circumstances many investors opt for safe and inflation-proof assets, which in turn will increase the price of gold above the trend.

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