Gold Dumped in the 2008 Credit Crunch : Will History Repeat?

Gold is a great Safe Haven Asset, but it doesn’t always do its job as you’d expect. I’ve been meaning to write about some of the different scenarios that might resolve this giant debt Ponzi that we have in our global financial markets and one of those scenarios is a repeat of the 2008 Credit Crunch (subsequently re-named the less-descriptive "Global Financial Crisis") yet WITHOUT the bailouts. In the last couple of days I’ve moved this scenario to the top of my list.

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But rather than go into specifics of how I think that scenario might play out (another day perhaps), I’ll go back and revisit what happened in 2008 which was basically a massive Credit Crunch where assets across the board were liquidated and CASH became KING. When this happened, Gold actually sold off. I’d like to try and explain WHY as I think it’s important to try and understand some of the dynamics in play with the markets both back then, and now – because nothing structurally has changed in our financial markets since then. Indeed many problems are now just worse.

The above chart shows the Gold price in US Dollar terms from the point where Bear Sterns collapsed in March 2008, which is considered by most to be the major trigger for the Global Financial Crisis in 2008. As you can see, it fell from a high of $1,030.80 USD in Mid-March to a low of $680.80 USD in Late-October which was a drop of about 34% during the height of the crisis.

To put that in perspective, the Dow Jones dropped from about 12,000 to about 8,000 over the same period – which is about the same 34% in percentage terms. In other words, even if you saw the crisis coming and pulled your money out of stocks to stick it in Gold as a Safe Haven you would have been no better off!

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Of course, as 2009 began Gold started to recover while the Dow would make new lows but my point here is that during the height of the crisis, Gold failed to protect the wealth of those who sought to use it as a Safe Haven against crisis. The question so many have asked since then is why?

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The answer comes down to the debt and leverage that are associated with Asset Bubbles. There are speculators and traders who borrow money to invest in assets. By doing this they are able to gain “Leverage” on price moves. So if the Asset they invest in goes up by 1% but they are leveraged by x10 then they will gain 10%. What happens when a big bull run occurs in places like the stock market is that these speculators and traders can get a bit complacent and take on large loans to leverage the market. Sounds risky? That’s because it is.

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What happens when a market starts to drop is that the lenders (usually some financial institution) gets concerned about the value of the asset in proportion to the amount on loan and if there isn’t enough collateral they issue a "Margin Call". This forces the speculator/trader to either sell the asset (making the price drop worse) or come up with more of their own money to provide more of a buffer that the lender is comfortable with.

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In the 2008 GFC this is why it was originally termed a Credit Crunch and this is where Gold comes in. Those speculators and traders needed money and they needed it fast. So they sold stuff to get money to satisfy their Margin Calls and they sold Gold. This is why Gold and a lot of other assets got hit during the height of the crisis. CASH was KING and those who had it made out like bandits as they could buy assets at fire sale prices. It wasn’t until the bailouts and money printing…ahem, “Liquidity Injections” really got started that Gold started to take off.

The moral of this story is to Diversify
Gold is a great Safe Haven but it doesn’t always work

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