We know, it’s just a symbol. But it’s a powerful symbol of the most severe
recession since the Great
Depression. Yup, it’s another article about the Lehman Brothers’
collapse. But we really invite you to read it, as we thoroughly analyze the
impact on that bankruptcy on the price of the yellow metal. You will also
find out what can we learn from the 2008 banking crisis for the gold market.
Ten years! Really, we did not believe, but the calendar does not lie. Last
month, a decade has passed since the Lehman’s bankruptcy. As people love
round anniversaries, everyone is reflecting now upon that event. So we
decided to put our two cents into the discussion. What we have learned over
the past ten years about the Great
Recession – and the gold market?
Let’s start from the price developments. The chart below shows the gold
prices since the Lehman Brothers’ collapse. The obvious conclusion is that the
last decade was overall positive for the shiny metal. Its price on
September the 11th, 2018 was about 60 percent higher than on September the
12th, 2018, just before it all began.
Chart 1: Gold prices (London P.M. Fix, in $) since the Lehman
Brothers’ bankruptcy
However, it is as obvious as a simplified observation. The more accurate
description is that when the Global Financial Crisis burst, there was
an impressive rally
in gold until September 2011, when it peaked. As the confidence
returned to the financial markets, the gold
bull market switched then into the bear
market, which basically lasts until today (alternatively, we can say that
gold has been in a sideways trend
for a few years).
But let’s dig into the gold’s price behavior around ‘Lehman moment’ even
more. As one can see in the chart below, the price of the yellow metal
rallied in the second half of 2007, as the global economy started to reveal
signs of an impending turmoil. However, after the Fed rescued Bear Stearns in
March 2008, the price of gold plunged from $1,011 to $750 just before the
Lehman Brothers’ bankruptcy on September the 15th, 2008. After that, it
initially increased from $750 to $775. Gold continued the rally until
September the 29th, when it reached $905.
Chart 2: Gold prices (London P.M. Fix, in $) around the Lehman
Brothers’ bankruptcy (from September 2007 to September 2009)
However, it started to decline then, plunging to $712.5 (lower than before
the rally) on October the 24th, 2008. It moved again above $1,000 not earlier
than mid-2009. How could it be that in the very midst of the
financial crisis and the most severe recession
since the Great
Depression gold prices plunged instead of soaring? The reason is
that in the dollar-based monetary standard, cash is king. When the crisis
erupted, market participants desperately needed liquidity. Hence, they started
to sell their gold (either their own or borrowed) to obtain greenbacks
needed to pay dollar-denominated debts. Another factor was that after its
bankruptcy, Lehman had to liquidate its positions, including gold.
This is the first lesson from the 2008 banking crisis for the gold market.
The yellow metal served as a hedge but in a sense that it was a source of
liquidity. Hence, when the next financial crisis hit, the gold prices
might initially fall before they started to rise. However, it does
not have to be a reason to panic, as falling prices may be a signal of fire
sales of markets on the brink of collapse.
The second lesson from the Lehman’s collapse is that the price of
bullion started to rise when the effect of fire sales dissipated and when
central banks’ activity became clear. The Fed
injected liquidity and slashed interest
rates almost to zero.
This is why we devote a lot of time to analyze the US
monetary policy – it’s one of the most important drivers for the gold
prices.
The third lesson is that the first two lessons are useless. We are, of
course, joking – but only to point out that the next crisis will not
be like the last one. The commercial banks – including the
systematically important financial institutions, such as Goldman
Sachs, JP
Morgan, or even Deutsche
Bank – improved their capital, so the banking crisis is somewhat less
likely. Hence, the gold will probably behave differently. For example, as
central banks widely expanded the list of eligible collaterals, investors
might not be forced to sell gold to obtain dollar liquidity. Therefore, the
price of yellow metal may not drop initially when the next crisis bursts.
Another key difference is that the market participants are now accustomed
to the quantitative
easing. Hence, unless the central banks implement even more sophisticated
tools of unconventional
monetary policy (like negative
interest rates), they should not panic – and the price of gold
should not rally, at least not as much as in the period between
2009-2011.
On the other hand, the US
fiscal position is now much worse than in 2008. Therefore, when the next
crisis hits, the budget
deficits will balloon, boosting the already high public
debt. It should be negative for the dollar and positive for the
gold prices.
The take-home message is that investors have to take into account the
broad macroeconomic context. We mean the specific features of the given
crisis. Not all recession are alike. They could be less or more severe. And
only some of them are accompanied by the financial or banking turmoil. These
are the best for the yellow metal. But if the next global crisis
looks more like the Asian
Financial Crisis – and there are some convincing arguments in favor for
such scenario – rather than the 2008 Global Financial Crisis, the
gold prices may actually not rally.
If you enjoyed the above analysis and would you like to know more about
the macroeconomic outlook and the gold market, we invite you to read the
October Market
Overview report. If you’re interested in the detailed price analysis and
price projections with targets, we invite you to sign up for our Gold &
Silver Trading Alerts. If you’re not ready to subscribe yet and are not
on our gold mailing list yet, we urge you to sign up. It’s free and if you
don’t like it, you can easily unsubscribe. Sign up today!
Thank you.
Arkadiusz Sieron, Ph.D.
Sunshine Profits‘ Gold News
Monitor and Market
Overview Editor
Gold News Monitor
Gold
Trading Alerts
Gold
Market Overview
