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2008 Financial Crisis Set Stage For Gold Rally

By Debbie Carlson of Kitco News
Monday October 13, 2014 9:43 AM

Editor's Note: This article takes a look back at what happened to gold five years ago after the financial crisis hit and the Federal Reserve responded.

(Kitco News) - Gold prices rose in 2009, the year after the worst financial crisis since the Great Depression, gaining about 24% by year’s end.

But much of the stage was set in 2008 for gold’s rise in 2009 – and for the next few years – when the global financial crisis was entering its darkest days. To recap what happened in the last quarter of 2008, the U.S. Treasury seized control of mortgage lenders Fannie Mae and Freddie Mac in September 2008 and said it offered a $200 billion cash injection for firms dealing with mortgage default losses.

Image courtesy of Richard Baker, editor, Eureka Miner. Click to enlarge

In October 2008 all markets – gold included – fell sharply as the credit markets seized up. At the time gold was being sold as investors sought funding to shore up losses in other markets. The U.S. government began working on bailout plans in October 2008, which was the depth of the global financial crisis. That month Congress approved the Troubled Asset Relief Program, a $700 billion bailout plan crafted by the U.S. Treasury Department and the Federal Reserve.

Looking at a futures continuation chart, gold fell as low as $681 an ounce on Oct. 24, 2008, but settled at $729.10. It rebounded into the end of 2008, settling at $884.30, up about 5% on the year, being one of the few markets to settle the year with gain.

At its December 2008 monetary-policy meeting, the Federal Reserve took several actions to stabilize markets and the economy. First, it voted to reduce the Federal Funds target to a range of 0% to 0.25%, where it currently remains. (The Federal Reserve Bank of St. Louis has a timeline of events and policy actions during the financial crisis from 2007 to mid-2009)

Second, it formally launched its first round of quantitative easing in December, saying it would buy up to $600 billion in agency mortgage-backed securities and agency debt. At the March 2009 Federal Open Market Committee meeting, the Fed further expanded its balance sheet by purchasing an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to $1.25 trillion at the time. It also increased its purchase of agency debt by $100 billion to $200 billion and purchased up to $300 billion in longer-term Treasury securities over the next six months to improve conditions in private credit markets.

In subsequent years, the Fed would go on to expand the QE program, although in October it is expected to end the asset purchase program altogether.

Richard Baker, editor, Eureka Miner, said the QE program helped to put a floor under gold, and really all asset prices.

“It was the start of the big reflation period,” he said.

He gave the example of another commodity that benefitted from QE.

“Right before Lehman Brothers (bankruptcy on Sept. 15), copper was trading at $2.50 (a pound on the Comex), then it dropped under $2 and by December was close to $1.25. That was a huge drop. But QE brought it up. I don’t think anything particularly good was happening at that period, really. QE has a lot to do with commodity prices rising.”

In an October 2009 research note from Dundee Precious Metals, there were several reasons why gold prices were expected to go up in the coming years, including fiscal and monetary reflation, investment demand, the bullish price cycle in gold and geopolitical worries.

Baker said looking back five years ago, he contended that the QE program had more to do with gold’s strength than safe-haven buying. For instance, from January until about September, gold prices held in roughly a $100-an-ounce range, between $900 and $1,000.

“It’s tempting to go back and just say it was a safe-haven trade. The facts are that yes, it would go up, but then settle back down. The thing that no one really remembered is after financial crisis, people weren’t lined up to buy gold. It held in a range between January and September,” he said.

Gold finally broke out of its range by Oct. 1, 2009, rising above the $1,000 level, and didn’t look back for the rest of the year. Comex gold futures settled at $1,096.20 an ounce on Dec. 31, 2009, a 24% rise from the Dec. 31, 2008 settlement of $884.30. In 2009, gold prices rose as high as $1,227.50 in early December before retreating into the year’s end.

Baker pointed out that gold prices slid the day that the Standard & Poor’s 500 set its intraday low around 666 in March 2009.

“That surprised me, that gold fell the day that S&Ps hit their intraday low,” he said. “Some people point to the following Monday when the S&P’s closing low was the lowest, but to me the day of terror was the intraday low at 666. I remember watching it in real-time. I thought that was more terrifying than the following Monday,” he said.

So, he said, it’s likely that all the government spending, including QE, plus the concerns about inflation because of the extra liquidity, didn’t start to have a cumulative effect later in 2009.

Gold-coin sales and investments in exchange-traded funds also picked up during 2009, particularly toward year-end. The full-year 2009 American Eagle coins sold by the U.S. Mint totaled 1.82 million coins, with 1.33 million of those being one-ounce gold coins. Looking at monthly breakdowns, volumes were higher in the beginning of the year, which is common, but volumes rose toward year-end. Comparatively, in 2008, the U.S. Mint total American Eagle gold-coin sales were 1.17 million, with 794,000 of those one-ounce coins.

The SPDR Gold Trust ETF (NYSE: GLD) saw inflows rise during 2009, with holdings increasing to 1,133.62 metric tons as of Dec. 31, 2009, versus 780.23 on Dec. 31, 2008, again with holdings rising toward year end. Current gold ETF holdings are back to the mid-2008 levels.

Gold prices are still above their December 2009 levels, but are down significantly from their all-time nominal highs set in 2011. Gold is in a downtrend like other commodity markets, but some commodities like corn, soybeans and platinum are making five-year lows.

“We’ve almost gone full circle. It’s true in dollar price, but also gold’s relation with copper, silver, oil, is roughly the same when we started out in 2009. It’s almost like a big normalization going on,” Baker said, as the Fed is ending its quantitative easing program.

For instance, he said when looking at gold prices compared to an aggregate of copper, silver and WTI crude oil from five years ago and earlier this month, valuations are not much different. As of Oct. 2, 2014 it took 404.4 pounds of copper to buy an ounce of gold, and on Dec. 31, 2009, it took 317.8 pounds. The gold/silver ratio was at 71.21 on Oct. 2, but stood at 66.55 on Dec. 31, 2009. The gold/crude oil ratio was 13.40 on Oct. 2, and was 14.02 at the end of 2009.

Baker offered this suggestion as why this might be happening: “Investment interest is drying up in commodities and now we’re back to old supply/demand fundamentals that move commodities, so you might expect that normalization. With demand going down, makes sense prices will fall.”

By Debbie Carlson of Kitco News; dcarlson@kitco.com
Follow me on Twitter @dcarlsonkitco



Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.

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