Canada’s precarious dependence on the commodity price super-cycle – by Alex Carrick (Journal of Commerce – May 7, 2013)

Chief Economist, CanaData

Mid-April was not a good time for Canada’s raw materials sector. In the course of just a couple of days, an already weakening price of gold surrendered all restraint and plunged the most in three decades.

Falling from its most recent high of $1,900 per ounce to a low of $1,350 per ounce, gold has exhibited a “bear” market. The usual definitions of “bull” and “bear” markets are asset value swings of at least +20% and -20% respectively.

From its previous peak to most current trough, the price of gold fell by nearly 30%. It has since recovered slightly.
Three primary reasons are cited for the floor-dropping air pocket.

First, inflation is still nowhere to be found. Canada’s latest year-over-year increase in the Consumer Price Index (CPI) was only +1.0%. In the U.S., April’s inflation rate was a slow +1.5%.

Gold is usually seen as a hedge against rapid price run-ups. Central banks around the world have been keeping interest rates low while rapidly expanding the money supply. The Federal Reserve in the U.S. has been buying $85 billion per month in bonds and the Bank of Japan is about to embark on a similar 7.5 trillion-yen per month ($75 billion U.S.) bond-purchase spree.

Such loose monetary practices are supposed to cause an inflationary flare-up. So far, the impact has been negligible. Cries of alarm about imminent inflation are wearing thin. Doomsayers are growing fatigued.

Second, there is increasing speculation that the quantitative easing program in the U.S. will be terminated at the end of this year. This will remove another prop to worries about inflation.

Third, as part of its deficit and debt busting efforts, the central bank in Cyprus plans to sell off much of its (relatively small) gold reserves. This has led to concern that other central banks, particularly in the financially distressed Euro zone, will follow suit.

Some of the price drop is in anticipation that there will be more gold for sale.

Naysayers like to point out that gold has little “intrinsic” value. That it has few industrial uses. That it derives its supposed worth from historical precedent.

Nevertheless, there’s something about its visual and tactile nature that has always made it appealing — from ancient times in Babylon and Egypt, through Aztec and Inca treasure troves, right up to the present. Even for modern couples, weddings aren’t “official” without a gold band.

Some analysts believe the price will drop to as low as $1,000 per ounce, bringing gold closer in line with its historical relationship to other commodities. But there’s also the alternative view that it will return to its previous high, probably not right away — since too many people have been badly burned in the latest collapse — but not so far in the future as one might suppose.

The largest portion of gold purchases globally is in the form of jewelry and coins. Rapid additions to the middle class in emerging nations will fuel further demand. Customers in China and India already account for about half the world’s sales. For many consumers in those two countries, as well as elsewhere, the drop in price is seen as a buying opportunity.

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