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2 Reasons the Gold Bubble Burst in 2013

In hindsight, I think we can all agree that the gold bubble has officially burst.

After peaking in September of 2012, the precious metal's price dropped nearly 30% by the end of last year, extracting a commiserate amount of value from the largest gold exchange-traded funds, the SPDR Gold Shares (NYSEMKT: GLD  ) and the iShares Gold Trust (NYSEMKT: IAU  ) .

What's less obvious is: Why? What was the catalyst for the precipitous decline? Did consumers stop purchasing gold? Was it the result of monetary policy? Or are speculators to blame?

The answers to these questions are laid out in a report released this week by the World Gold Council, a global authority on gold and its uses. As the authors note (emphasis added):

The gold market became polarized in 2013 as 21% growth in demand from consumers and value-seeking investors contrasted with large-scale outflows from ETFs. The net result was a 15% decline in full-year gold demand in a year where jewelry, bar, and coin demand reached an all-time high.

The fact that speculators were behind the drop -- as evidenced by the cited "large-scale outflows from ETFs" -- is borne out in the numbers. In 2012, ETFs were net buyers of gold, purchasing an estimated 279.1 tons of the precious metal. In 2013, they transformed into net sellers, offloading a staggering 880.8 tons onto the market.

What, in turn, triggered the change in investor sentiment?

Beyond profit-taking, the outlook for interest rates changed dramatically in 2013, with analysts and commentators predicting the Federal Reserve would begin reversing course on its third round of quantitative easing. And because real gold prices and real interest rates are inversely correlated -- when real interest rates are low, real gold prices are high -- it seems reasonable to conclude that this served as the ignition switch.

With this in mind, the outlook for the future of gold prices seems dismal. Just last week, the newly appointed Fed chief, Janet Yellen, made it clear she intends to continue the central bank's current policy of tapering. Over the long run, this should continue to push interest rates up, and, if the historical relationship holds true, gold prices down.

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Read/Post Comments (6) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 22, 2014, at 3:26 PM, GaryDMN wrote:

    Consider supply and demand. Demand has been rising, but there was an abundance of recycled gold that was created when gold prices were at a high and ordinary people sold old jewelry and collectables to gold dealers that seemed to cop me out of the woodwork, after prices went up. Much of the UKs gold reserve went to Switzerland and then to China. This abundance of non newly mined gold and falling gold prices, forced gold miners to scale back their plans and close higher production cost mines. Now we will face growing demand for consumer gold from Asia and falling inventories. The gold miners now have lower production costs, but will not be able to meet demand. Gold prices will go up, just based on supply and demand, but gold miners, will be the big winners.

  • Report this Comment On February 22, 2014, at 3:42 PM, MrRand wrote:

    The establishment is terrified of gold. They are terrified that confidence will be lost in the dollar and that the dollar will collapse. Well it's coming and the dollar will collapse. History proves that all fiat currency has collapsed due to excessive printing with no standard. Good luck with the paper when it hits the fan. Google Weimar Republic hyperinflation and see the pictures of Germans using a wheelbarrow to buy a loaf of bread.

  • Report this Comment On February 22, 2014, at 5:07 PM, jb3415 wrote:

    This is an extremely simplistic (and thus false) take on has been happenig with gold. Surely the rise of gold ETFs made it easier for the mainstream investor to jump in and then out of gold, but there is so much at play now. Focusing simply on the old interest rate narrative is going to leave you with egg all over your face.

    The manipulation of the fed abd bullion banks has been relentless. Why? it's about the dollar and the extent to which QE is destroying it. Without these relentless, sustained attacks on the price of gold, the market price would be several times it's current price.

    China's gold purchases have been as reletless as the Fed's suppression. Demand for physical gold has never been stronger. In what other market could you envision a large player buying up pretty much all of annual production, draining all the western stores of product, while the price (in paper terms, anyway) simulateously drops like a stone. Before you write anothr article about gold, you need to think this through.

    The physical market for gold is separating from the paper market and moving east. Supply is drying up fast. Currency debasement is the order of the day. Inflation is spreading across the globe like wildfire.

    Do the math....

  • Report this Comment On February 22, 2014, at 5:20 PM, jb3415 wrote:

    It should also be noted that these gold "smack down's" by the Fed started with Germany's repatriation request. I don't know if you've followed this saga (it's been supressed in the US mainstream press...but not in europe), but this situation revealed that the US is essentially out of gold...that it has sold, leased and rehypothecated notonly all of it's own gold but that of the other countries that trusted the Fed with their gold.

    The gold smackdowns were designed not only to support the dollar but shake gold loose from weak hands 9the ETF holders) to meet growing central bank demand.

    Central banks now know the deal / understand what the Fed has done, and thus are frantically securing all the physical gold they can get their hands on.

  • Report this Comment On February 23, 2014, at 8:23 PM, luckyagain wrote:

    GaryDMN - seems to have the best explanation. Gold is like any other commodity that is traded in the free market. It can go up and it can go down. So is it due for a sustained upturn? I do not know and I doubt that anyone else really knows. So if it makes you feel better to own some, than buy what you need to make you feel better. The gold miners seem to be a better buy for investors. The key question about the gold miners is what is their actual cost which seems to be very hard to determine.

  • Report this Comment On February 25, 2014, at 2:37 PM, mislaidkiwi wrote:

    First off, I think the author intended to say "commensurate" not "commiserate" - unless he is sympathising with those who bought at $1800.

    Next, even after the complete elimination of QE (maybe) in a year or two, we'd still be in an extremely distorted monetary regime. From the very Fool article referenced:

    "... there's still lots of slack in the labor market, and until it tightens up the Fed will keep interest rates low."

    Finally, it seems that the investment advice can be summarised as:

    - Buy high priced stocks, 30% up in 2012.

    - Sell low priced gold, 30% down in 2012.

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John Maxfield

John is The Motley Fool's senior banking specialist. If you're interested in banking and/or finance, you should follow him on Twitter.

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