Greece is bad for gold

Despite the current fears that a Greek default and exit from the Eurozone will have damaging ripple effects, the price of gold continues to trend lower. At just under $1160/oz., it is almost 40% below its 2011 high of $1900. Gold hasn't benefited at all from the Greece turmoil—in fact, it's moved lower. What's going on? I think there are two things happening: 1) declining risk aversion and 2) a realization that the Greek problem is not such a big deal, as I pointed out in a post last week.

Gold needs lots of fear and trembling to move higher. Note that gold prices peaked in the latter half of 2011, right around the time that the PIIGS crisis peaked (second chart, which shows the yield on 2-yr government bonds). Several countries, larger and more important than Greece, were flirting with default in late 2011, and the world feared the collapse of the entire Eurozone. At the same time that gold prices peaked, government yields and 2-yr swap spreads were on the moon. Today, 2-yr Portugal yields are a mere 80 bps, while 2-yr Spanish yields are 42 bps; 2-yr Eurozone swap spreads are only 40 bps. Yields and swap spreads are way down, and gold prices are way down; it's all part of the same story—less panic, a bit more confidence, and liquid, functioning financial markets.

Gold is falling because Greece is not a major threat and there is little or no evidence of any systemic risk. As the first chart above suggests, gold is also falling because the demand for safe assets (e.g., gold and 5-yr TIPS) is falling. (Note that I've used the inverse of the real yield on TIPS as a proxy for their price.) The world is still quite risk averse, as I noted yesterday, and gold is still trading at elevated prices: over the last century, the real price of gold has averaged about $550/oz. But things are slowly getting less risky, and investors are slowly becoming a bit less risk averse.

Gold is also falling because commodity prices are falling. Both are falling because on the margin the dollar has been strengthening. Gold and commodities are both a refuge of sorts when the dollar is weak and there are fears that monetary policies will lead to higher inflation. Markets are somewhat less concerned about that now, as inflation has remained quite low throughout the developed world even as central banks have been very accommodative.

Greece is bad for gold because Greece is not a compelling reason to pay up for the safety of gold.

Unless things take a big and unexpected turn for the worse, equity investors will find it hard to justify hiding out in cash, especially when cash pays nothing and yields on alternative assets (see chart below) are much higher, systemic risk is very low, monetary policy is accommodative, and there is no sign of any significant weakening in the economic outlook.