LONDON (MarketWatch) — It is not often the financial markets reach a consensus. No one can agree whether the euro zone is now fixed or just getting ready for another crisis. Nor on whether the end of quantitative easing will crash the markets, or signal a return to normal growth. Or indeed on whether China is about to implode messily, or will power forward to dominate the coming century.
But at the start of this year there was one idea that everyone could sign up to. Gold was toast. The price GCJ4 +1.73% had been declining all through 2013, and was going to keep on going down.
But hold on. Gold had defied its doubters, and made a surprisingly strong start to the year. The price has risen 10% since Christmas, and it is now back above $1,300 an ounce. The metal has had its best start to the year since 1983.
And yet, traditionally, a rising gold price has been a warning sign of trouble ahead.
Investors buy gold in times of economic turmoil. So what kind of warning is the precious metal sending us right now? There are three possibilities — a crash in China, the arrival of deflation, and a fresh recession in the developed world. Whichever it is, gold had been more often right than wrong in the past — and it would be foolish to ignore it now.
The financial markets have not run according to the script so far this year. Equities were meant to power forward as the global economy recovered, bonds would tank as central banks stopped printing money, and gold would go back to being the “barbarous relic: that Keynes dismissed it as. None of that has happened, and gold, in particularly, has gone wildly off-message. After experiencing its worst slump in three decades in 2013, it is now rising fast again.
Of course, there may a perfectly innocent explanation for that. The speculative buying of gold, particularly by the huge exchange traded funds that were launched to ride off the bull market, has now been flushed out. In its place, there is a steadily rising physical demand, particularly in countries such as China, where there is a lot of new money. Last year, consumer demand for gold rose by 21%, according to the World Gold Council, mainly in India and China. While that was swamped by people fleeing the investment market in 2013, with the hot money out of the game, rising real demand could be simply re-asserting itself.
But the rising gold price might also be an early warning sign of big trouble ahead. If so, what might that be? Here are three possibilities.
First, and most obviously, China.
No one knows for certain what is happening to the Chinese economy, partly because the statistics are so untrustworthy. What we do know is that there has been a massive buildup of credit, and the country’s turbo-charged growth is starting to slow, and that is seldom a happy combination. China’s new rich have been putting their money into a new breed of unregulated high-yield wealth management products, many of which have turned out to be about a reliable as a Florida subprime mortgage application in 2007.
If that money heads for the exit, and the economy starts to wobble as well, then Chinese investors will switch into gold as their traditional safe haven. A wall of money will hit the precious metal. How big could that be? Enough to make a big impact on the price, that much is for sure.
Second, deflation .
The market has decided just to ignore the way that deflation is starting to get a hold on the euro zone. But it may not be able to remain indifferent much longer. Figures released on Monday showed consumer prices dropping at their fastest rate since records began. Cyprus and Greece now have falling prices year-on-year. Italy cannot be far behind. Prices there fell by 2.1% in January, and in France they fell by 0.6%. Falling prices are partly an indicator that the economy is in fresh trouble — after all, companies don’t cut prices because the demand for their products is booming.
But it also catastrophic for nations that have very high debt levels — such as all the peripheral members of the euro zone. The debts remain the same, while the income to service then shrinks every year, and if your debt-to-GDP ratio is already 130% as it is in Italy, then that is a big problem.
If deflation does take hold, then two things follow. It may well move the euro crisis into its third and final act, paving the way for a final breakup. Or else the European Central Bank will be forced to launch quantitative easing on a massive scale to try and stop prices collapsing, and taking economies down with them. Either is certainly going to send gold upwards in price.
Finally, the next recession.
Hang on, you might say. We still haven’t finished with that last one. It is true that most economies are still painfully emerging from the dramatic slump in output that followed the financial crisis of 2008. But that does not mean the business cycle has been abolished. In the normal course of things, the economy slows down every four or five years. If the recovery started — admittedly very slowly — in the middle of 2009, then there would be nothing very surprising about a slowdown later this year, and some kind of shock before the start of 2016 is just about inevitable.
There are already signs of slowing growth everywhere, from weak jobs growth in the U.S., to turmoil in the emerging markets. The recovery from the crash of 2008 is likely to be a one- or even two-decade process. There will be bumps along that road, and we are about to run into one. The gold price may well already be forecasting that.
Gold has a long and impressive record of warning of trouble ahead in the global economy. It has usually been right in the past — and it is telling us right now that the outlook is much less secure than the market assumes. You ignore it at your peril.
