How recently it was that many in the trading and investment community believed that gold was the one investment that could continue to rise in almost any economic environment. If recession fears and concerns over credit issues in Europe were escalating, gold was a play on the lack of confidence in governments. If economic growth and inflation were picking up, gold was simply a play on currency devaluation. Either way, gold has been the best performing asset at many times during the last several years of market rallies and sell-offs. Interestingly though, the trend of late seems to be breaking.
With gold recently topping out just above 1900 several months ago, the Teflon metal has been stuck at the bottom end of a range between 1550-1750 for some time. Given that many of the financial and economic issues that caused investors to flock to gold over the last couple years are still unresolved, it's interesting to see that gold has been such a poor performing asset class over the last several months. The question is: what has changed?
I think the first factor that has caused gold to perform so poorly over the last several months is exhaustion over the European debt crisis. Now that the Fed has backstopped some European loans into the U.S. economy, the ECB has been willing to continue buy Italian and Spanish bonds, a major blow-up in Europe is seeming increasingly unlikely. While the European economies have weakened, recent PMI data shows that economic activity in the Euro-Zone is not imploding. Additionally, with the same European debt issues constantly being brought up over the last nearly three years, the market seems content to believe that the PIIGS various debt issues will not cause a financial catastrophe anymore than they were one or two years ago. The VIX is now comfortably below 25, equity markets around the world have held up well, and the Euro continues to decline in a stable manner that is likely to benefit Europe's export based economy. Fears of a credit event or recession-like occurrence resulting from a credit event in Europe have diminished significantly.
The second major factor that has changed in the last several months is investor confidence in the dollar. When fears over the European debt crisis were peaking in September, investors and traders were concerned that a moderate to severe recession would occur in the U.S. Now that the economic data in the U.S. clearly indicates that a recession is unlikely, capital that is leaving Europe seems content to come to the U.S. rather than go to a traditionally average performing asset like gold. Spending in the U.S. has been curtailed significantly, and the Fed has not pursued in any new monetary policies since the end of the second round of quantitative easing. The U.S. economy also appears likely to continue to expand, albeit at a very slow rate.
In short, investors and traders seem comfortable moving capital in the dollar and U.S. markets rather than parking it in gold and other hard metals. The move in capital to the U.S. dollar because of the relative strength of the U.S. economy has also enabled the Euro to come down against the dollar in a slow and controlled fashion that should benefit Europe's export based economy quite nicely. Indeed, the dollar appears to now be a safe heaven not just because of fear, but also because the U.S. economy is holding up fairly well compared to Europe and emerging market economies. The fact that U.S. spending levels have come down while the Fed has been much less active in pursuing new more aggressive monetary policies has also eased fears over inflation or further new currency devaluation.
The fact that significant government spending efforts and more aggressive monetary policies by central banks are unlikely to be pursued in the current financial and political environment should also cause gold investors to question if investing in inflation hedges is the best current place to allocate capital. While Europe is now cutting interest rates for the first time in some time, European governments are spending very little, and the ECB is not printing money or pursuing any new forms of quantitative easing like we saw the Fed do several years ago. Likewise, in the U.S., the tea party's influence in congress has prevented any significant new spending programs, and the Fed has also indicated that new quantitative easing efforts in the near-term are unlikely.
Even while the emerging markets are beginning to cut interest rates aggressively, Europe and the U.S. seem content to cut spending and not pursue any aggressive new monetary policies. With the U.S. in an election year and Europe facing huge budget deficits and diminishing revenues, near-term changes in fiscal and monetary policy seem unlikely in these economies. The policies that the U.S. was pursuing to devalue the dollar and stimulate the economy have been tempered severely. Likewise, while Europe's interest rate cuts are a shift in their monetary policy, European governments and the ECB have been unwilling to pursue aggressive new forms of quantitative easing similar to what we saw the Fed do several years.
To conclude, gold has had a great run over the last decade, and was particularly strong from 2009 to 2012. Still, now that markets have stabilized and fear levels have come down, it's worth reevaluating investment opportunities. While gold certainly makes sense as a portion of most people's portfolios, if governments and central banks are no longer aggressively trying to stimulate growth, inflation is likely to remain subdued. With fears over a major credit event in Europe or new recession in the U.S. having diminished significantly, gold is not likely to rise significantly on renewed concerns over the nearly three year old European debt issues. Now that the economic data is showing that the U.S. should continue to grow at around 2% a year, conservative investments in equities should continue to outperform most metals if inflation remains subdued. While global growth remains tepid and the European debt crisis is far from solved, it's worth asking if gold's best days are now behind it. Gold historically has returned about 5% a year. With many conservative stocks yielding between 5-7% a year and equities normally returning around 8-10% over the last several decades, investors may want to look elsewhere for returns in 2012.