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.