From riches to rags

Earlier this week, the price of gold dropped 15 per cent in just two days. Gold prices haven’t fallen so sharply since Margaret Thatcher’s first term as prime minister. Some have argued that the decline is due to expectations of greater gold supplies due to Cyprus having to sell off some its gold reserves to pay for its bailout. But Cypriot gold reserves are relatively small, so it’s hard to see how this provides the explanation for such a major nosedive in price.

Photo credit: hto2008

A more convincing explanation relates to the way in which gold is considered to hold its value, meaning that it’s an attractive investment for those looking to avoid their wealth losing value over time. But now it’s been suggested that speculators have been deciding to stop buying up gold (or more accurately, gold contracts – they don't get their hands on the metal itself) because they’ve decided that recent fears of inflation caused by quantitative easing are unfounded.

But while this may well be a factor, it’s more likely to happen through a gradual change of attitude since there’s no single event which would have changed investors’ minds en masse – until now.

Gold is subject to high levels of speculation: in 2011, the volume of gold traded on financial markets was ten times the amount of gold mined throughout the entire course of history. It seems that for most of the last decade, gold prices have been kept artificially high by speculation – but now finally the bubble has burst.

Once prices start falling, speculators tend to believe that prices will continue to fall, and they would be best to sell their gold contracts before they lose more money. As David Govett, head of precious metals at brokerage Marex Spectron puts it: “This is a market that has only got one thing on its mind: get me out [of gold]”. The result is a self-perpetuating downward spiral of prices. David Rose, global head of metals trading at HSBC, explains: “People are asking ‘How much do we really want gold to be part of our portfolios?’”

But what’s all this got to do with global poverty? Well, it’s another example of how speculation can distort commodity prices, pushing them up to artificially high levels. The real world impacts of this may be less acute for gold prices compared to those for maize or wheat, but the principle is the same.

It also shows that so-called bubbles can last a very long time before they finally burst. Critics of action to regulate speculation on food and other commodities often argue that there’s no need for intervention because if bubbles do develop and prices shoot up, the ‘efficient market’ ensures that they quickly burst, bringing prices back down again before any harm is caused.

If food prices rise for an hour, then fall again, people probably won’t see much impact on their grocery bills. But the example of gold shows that bubbles can last much longer than an hour or a few days. And if food prices are inflated for a month, year or even longer, the effects can be devastating.

The ‘efficient market’ may be a nice-sounding theory, but - unfortunately for those at the sharp end of unregulated markets - it’s no more than that.