As it says in Ecclesiastes, there’s nothing new under the sun—and nowhere is that more true than the recent gold market. After a high flying start to the year, prices have moderated somewhat. On the surface one could expect a certain amount of consolidation (i.e. short-haul gold speculators taking the money and running), but there are factors pushing gold prices lower than profit-taking alone would account for. Perhaps a more accurate term than “factors” would be myths.
That’s because most of those factors have little to do with fundamentals. The biggest influence on gold prices is coming from investor perceptions rather than reality. A few strategic examples:
That Much-feared Fed Rate Hike is Already Figured In
The Fed has been talking about raising rates, literally, for years. But after all the talk, our central bank bumped rates just a measly quarter-point in 2015. At first the stock market and gold prices reacted, but both recovered quickly. Another quarter-point in June will add up to a slightly significant rate increase, but nothing the market hasn’t been prepared for since 2014. In the world of finance one-half of one percent is a rounding error. The stock market, bond market and gold market will shake off a quarter-point hike, particularly since one of these markets (can you guess which?) really has no interest in interest rates…
Gold is Unimpressed by Interest Rates
It turns out there’s a very little correlation between gold and interest rates; in fact two far better indicators of gold performance are the stock market and strength of the dollar. Taking a look at the gold chart over the last ten years, we see gold prices coming down during a time of record low interest rates. But what else was going on from late 2011 until recently? One of the biggest recoveries in Wall St. history. Combine that with an incredibly strong dollar and you have a formula for commodity prices…any commodity…to move lower. We saw it across the board in commodities, not just gold, with the oil and energy industries taking the worst of it. In comparative terms, the yellow metal has held up intriguingly well. Then again, gold’s no ordinary commodity.
The Gold Market is Global
It wasn’t that many years ago when the health of the global economy and health of the U.S. economy were synonymous. It’s only this younger generation that’s now growing up in a world where the U.S. is just another player on the world stage. Although that may sound like a worrying development, as with any big change it’s not all bad—particularly for gold. With China opening the Shanghai Gold Exchange and taking a stake in the newly re-vamped London Gold Fix, the precious metal is now more of a global commodity than ever. With China making a concerted effort, not only to acquire tonnes of this key asset, but to have significant control over its pricing worldwide, anyone concerned with the security of their portfolio ignores gold at their peril.
Strong Dollar on the Wane
A far better indicator of gold prices is the strength of the dollar. The relationship is simple and straightforward: When your dollar buys more, logic dictates it will buy more gold. Since the numbers printed on currency can’t change on a daily basis, it’s the price of gold that adjusts. However some experts fear the dollar may be losing strength in 2016; which is why experienced investors use gold to hedge the buying power, now and in the future, of their currency.
A great deal is made about inflation and gold prices, yet that’s another poor correlation. Inflation is not a uniform force on the economy. When prices rise in one sector, those higher costs are frequently offset by reductions somewhere else. Consumers also make different buying decisions when inflation pushes prices higher; making generalized “inflation” too wobbly a metric to use as a predictor of gold prices.
Rather than trying to hedge against inflation, gold’s function in your portfolio is to hedge against the future purchasing power of your cash.