Lehman Brothers and Gold

Founded in 1850 by three brothers. It started as a dry-goods store to become later a commodity house and eventually a house of issue. Before its collapse, it was the fourth-largest investment bank in the United States (behind Goldman Sachs, Morgan Stanley, and Merrill Lynch). The symbol of the global financial crisis, whose collapse put the world into the Great Recession, the most severe economic downturn since the Great Depression. For some, a victim of the Fed’s decision not to rescue it. For others, the Bank of Evil, guilty of accounting frauds and responsible for the crisis. Lehman Brothers. Let’s analyze its link with gold and lessons we can learn from its bankruptcy.

Lehman Brothers Collapse and Gold

Everyone knows that the global financial crisis was positive for the gold prices in the long-run. However, the behavior of the price of the yellow metal was actually quite complicated around the ‘Lehman moment’. As one can see in the chart below, gold rallied in the second half of 2007, as the global economy started to reveal signs of an impending turmoil.

Chart 1: Gold prices (London P.M. Fix, in $) around the Lehman Brothers’ bankruptcy (from September 2007 to September 2009)

lehman brothers and gold

By the way, let’s emphasize one thing which is very often wrongly presented: the Lehman Brothers did not trigger the crisis. The company collapsed as a result of the unprecedented loss due to the continuing subprime mortgage crisis (as a reminder, in 2007, Lehman underwrote more mortgage-backed securities than any other firm) and the lack of political will to bail it out (just compare the Fed’s and Treasury’s decision to let Lehman fail with its tactic support for Bear Stearns, which was bought by JPMorgan Chase in March 2008.

OK, let’s return to the chart. After the rescue of Bear Stearns, the price of gold plunged from $1,011 to $750 just before the Lehman Brothers’ bankruptcy on September the 15th, 2008. After that, it initially increased from $750 to $775. Gold continued the rally until September the 29th, when it reached $905. However, it started to decline then, plunging to $712.5 (lower than before the rally) on October the 24th, 2008. It moved above $1,000 again not earlier than mid-2009.

Hence, the collapse of the Lehman Brothers was initially positive for gold, as it increased fear among traders. However, investors quickly started to  desperately need liquidity. So they sold their assets, including gold, to obtain necessary US dollars (Lehman Brothers also had to liquidate its positions, including precious metals). The implication is that when gold serves as a source of liquidity, its price might actually fall at the beginning of the crisis as a result of fire sales.

Now, the question is: who will be the next Lehman Brothers. Many analysts bet on Deutsche Bank, but it may just be someone else. One thing is certain: if we have another financial crisis in the US (the epicenter of the crisis is important, the replay of the Asian Financial Crisis may not be supportive for the gold prices), gold might not behave the same as in 2008, but its prices should generally rise.