Gold and the Debt Ceiling: 2011 Redux?

Recall that in 2011, it was the same crisis that led to ratings agency S&P downgrading US bonds that August. Gold bullion prices rose $300 per ounce to new record highs above $1,900.

The question now is, could it happen again? The answer is theoretically, yes, but probably unlikely. Consider that in 2011, gold was travelling on a pretty-much uninterrupted upleg that began mid-2008 and crested in August, 2011. In 2013, gold is in a bear market, having lost about 17 percent of its value year to date; unlike in 2011, this year there is talk of tapering quantitative easing, which would be very bearish for the precious metal.

The immediate effect on gold does not appear to be promising. The government shutdown that began Tuesday was good for stock markets but bad for the yellow metal. As Reuters reported, equities had fallen prior the shutdown, and many investors saw it as a buying opportunity. Gold, on the other hand, fell almost $40, crashing through the $1,300 resistance level to a two-month low of $1,289.90 an ounce.

It seems counterintuitive that gold should fall during what appears to be a very negative event for the US economy – a hiatus of government services and the even more catastrophic event of a default if Congress fails to increase the debt ceiling. Reuters explained the drop as likely caused by either a troubled fund selling its position in gold, or by traders who had earlier bought bullion as a hedge against the US budget crisis, only to sell it on the expectation the crisis will be resolved quickly. Oil, copper and silver also lost value on Tuesday.

As to what could happen next with gold, most analysts agree that the October 17 deadline is the one to watch.

Here is a smattering of the comments going around the Web right now on gold and the debt ceiling.

Analysts at Commerzbank said a repeat of 2011 is mostly unlikely but the deadline is still bullish for gold:

“In the worst case, the country could actually face insolvency, and while there is very little chance of it coming to that, such a development would seriously push up gold prices,” they said in a note to clients.

James Steel, chief precious metals analyst at HSBC, held much the same view, telling The South China Morning Post:

“We do not envisage the gold market to revisit the same euphoria seen during the debt ceiling crisis in mid-2011. Nonetheless, US debt ceiling concerns would still be viewed as positive for bullion.”

Gold commentator Julian Phillips said he thinks the instability surrounding the crisis can only be good for gold:

“If there is no resolution within the next 17 days we see the potential for an impact on the global system equal to the mid-2007 credit crunch. This will be more than a ‘game of chicken’ as it has been building up for years now,” he wrote. ”Uncertainty has taken over inside and outside the U.S. If not resolved, we will see instability take over from uncertainty. This is gold positive.”

Commodities Wrap explained that the failure of bullion to catch any breaks over the shutdown has to with the shutdown’s deflationary nature:

“The bearish reaction seems to indicate a market that sees the consequences of a shutdown as deflation. One source, quoted by Marketwatch, Yves Lamoureux, president of Lamoureux & Co., a market advisory firm based on behavioral economics, says as much, citing the shutdown as by its very nature ‘disinflationary,’ diminishing the value of bullion which is traditionally seen as a hedge against inflation.” 

Finally, Reuters Insider said that the shutdown could push the taper beyond the US Federal Reserve’s next meeting in October.

In a video interview published Tuesday, Reuters Insider quotes PIMCO portfolio manager Tony Crescenzi, as saying that without government data needed to pull together the September employment report, the Fed is unlikely to make a decision on quantitative easing at its October 18 meeting. He said the Fed is more likely to wait until December 18, when it has three employment reports to digest, on whether to pull back on its $85 billion a month bond purchase program.

Doing so is widely expected to further dampen the investment appeal of bullion, whose price has more than doubled since QE began in 2008.