By Ryan Vlastelica and Richard Leong
NEW YORK (Reuters) - The plunge in the gold price in the past week may have raised a big red flag over the global economy.
Some top investors say the gold sell-off, and the broader declines in oil and metals prices, reflect the failure of the Federal Reserve and other central banks to create robust demand even as they inject massive amounts of money into the world financial system.
The slide, which took gold to its biggest one-day loss ever in dollar terms on Monday, unnerved investors who saw billions of dollars in gains wiped out in a few days, and it may portend declines in other asset prices ahead. That may have begun this week with several days of big stock price drops.
Some see the move in gold as a possible flashpoint for a broader economic and markets shock comparable to the collapse of hedge fund Long-Term Capital Management in 1998 and even the financial crisis a decade later. Both events were preceded by sharp drops in gold.
The gold and commodities weakness is "signaling concerns about global growth," said Mohamed El-Erian, the co-chief investment officer of PIMCO, which oversees $2 trillion in assets. "Commodities have been sending the signal on growth for a while, and now even louder."
And after the stampede out of gold earlier this week, investors on Thursday dumped their holdings of U.S. inflation bonds after a lousy auction. This kind of debt is seen as a way to protect against any rise in the inflation rate that might materialize in a more buoyant economy.
The post-crisis run-up in gold prices resulted in part from speculation triggered by the massive amounts of cash created by aggressive monetary policy. It had been thought that the massive creation of credit would support a "re-inflation" of the world economy - but the recent pullback in gold, oil and copper - the latter two assets linked closely with global industrial growth - suggests that this may just not be happening.
The recent rush into the safety of U.S. Treasuries - which has pushed yields close to four-month lows - is another sign that the global economy is far from humming. Treasuries are often seen as a shelter when the economy is weak or unstable.
The PIMCO Total Return Fund
Some are even talking about the possibility the United States could head back into recession, though this is a minority view.
"It's not noise. There are fundamental consequences," said Komal Sri-Kumar, president of Sri-Kumar Global Strategies and a portfolio manager of the TCW Comprehensive Asset Allocation Strategy fund.
The International Monetary Fund on Tuesday dialed back its forecast on global economic growth in 2013 to 3.3 percent from its earlier projection of 3.5 percent. That is little changed from the 3.2 percent in 2012.
Concerns about slowing growth are also resonating within the Federal Reserve. Several Fed officials expressed worry about disinflation, including the more centrist James Bullard, St. Louis Fed president, who said on Wednesday that "if inflation continues to go down, I would be willing to increase the pace" of stimulus.
"The stars are lining up" for a significant dip in U.S. growth in the second half of the year, possibly even a double-dip recession by 2014, Sri-Kumar said.
It all raises questions about the effectiveness of the huge cash stimulus pumped into the world economy by the Fed, the Bank of Japan, and other major central banks.
With governments strapped for cash, the central banks have taken on a lot of the burden of getting the world economy back on a growth path after the devastation inflicted by the financial crisis. If the impact of those measures, such as the Fed buying massive amounts of government and mortgage debt, starts to show diminishing returns it could be a huge concern for investors in any riskier assets.
GOLD LOSING SHINE
The downdraft in gold prices coincided with mounting evidence of a slowing of the rate of price increases. On Tuesday, the U.S. Labor Department said U.S. consumer prices have increased by 1.5 percent over the past 12 months, the slowest rate of increase since July 2012.
Bank of America-Merrill Lynch recently warned that gold - which was trading at $1,392 an ounce late on Thursday - could fall to $1,200 before stabilizing, citing "fears of disinflation combined with news of potential central bank gold selling.
The sell-off in gold, together with weak economic data, knocked investors' long-term inflation expectations to their lowest levels since late last summer.
The yield gap between 10-year Treasury Inflation-Protected Securities and regular 10-year Treasury notes - used to gauge investors' outlook on inflation - 2.27 percentage points on Thursday, the lowest since early September prior to the Fed's announcement of its third round of large-scale bond purchases, known as QE3.
This 10-year inflation "break-even" rate, which the Fed monitors, was as high as 2.61 points in late January.
Meanwhile, three-month copper futures are down 12 percent this year, falling below $7,000 per ton on the London Metal Exchange for the first time since October 2011. Copper's importance as a use in industrial and housing applications - from autos to water pipes - has made it a key barometer of demand.
Some, however, believe the dramatic wind-down of the severe inflation of assets in the previous decade remains incomplete - making the declines in gold and other metals less disconcerting.
"Because the global economy is on the downside of a global credit bubble, it seems unreasonable to expect abnormal inflation," said Richard Bernstein, a long-time strategist who heads his own namesake investment advisory firm in New York.
In addition, gold has arguably been in line for a correction. Its price had risen for 12 straight years, and had gained 52 percent in the last three years, the kind of gains seen notably in technology stocks in the late 1990s.
"Even at these levels, gold is still not attractive. The odds favor the bull market being over," said Jim McDonald, chief investment strategist at Chicago-based Northern Trust Global Investments, which in early March told clients to stop allocating a position to gold.
As the outlook on inflation has diminished, investors have cut back on their gold exposure.
U.S. funds that invest in precious metals suffered a record one-week outflow of $2.7 billion in the week ended April 17, according to Lipper, a unit of Thomson Reuters, of which $2.2 billion came from the SPDRs Gold Shares ETF
The stampede out of gold has tapered off, and it has pulled back more than 5 percent from a two-year low of $1,321 an ounce hit earlier this week, leading to some hopes the declines are the result of a much-needed correction in the metal.
Still, investors are very wary of another plunge.
"If we see this kind of liquidation again, the equity market will follow. Then we'll have a real problem," said Frank Cholly, Jr., senior commodities broker at R.J. O'Brien and Associates in Chicago.
(Reporting by Richard Leong and Ryan Vlastelica, additional reporting by Jennifer Ablan and Sam Forgione; Editing by David Gaffen and Leslie Gevirtz)