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With Stocks Falling, Is It Time For Gold?

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Steve Pomeranz, CFP

Gold prices kicked off the beginning of the 21st century and the new millennium, on January 1, 2001, at about $270 per ounce… and steadily rose 7-fold to a high of $1,895 on September 5, 2011 – with an annualized gain of about 18% per year for that 11 ½ year period… driven partly by a rush to safety in response to the global mortgage and banking crisis.

Factors that Influence Gold Prices:

The perceived debasement of fiat currencies by the printing presses of the world’s leading central banks — including the US Federal Reserve — prompted investors to put money in gold and other ‘solid’ assets. And gold’s high coincided with the US debt ceiling crisis of 2011 that saw the federal government almost running out of cash before a last-minute deal stitched with Republican congressmen allowed the Treasury to raise its borrowing limit before the deadline ran out.

Simply put, gold prices have gone up whenever public confidence in the dollar — the world’s reserve currency — has suffered erosion. This is hardly the case today, with the US economy recovering from a recession even with low inflation — defying dire predictions of an imminent dollar collapse. The best proof of it is the US dollar index, which measures the value of the greenback relative to a basket of six other global currencies. The dollar index (base: March 1973 = 100) is currently close to 98, compared to the low of 72.93 on April 29, 2011 when the American economy was still sputtering. A strong dollar has made the world somewhat less pessimistic about fiat currencies, while reducing the allure of gold as a safe haven asset.

Gold has long been favored as a safe harbor for investors in times of uncertainty, as a hedge against inflation, recession and a weaker US dollar. But neither inflation nor the US dollar have been an issue, with the dollar remaining strong and inflation staying low. So as the U.S. economy has strengthened, investors that had flocked to gold and bid up prices after the 2008 crisis, have slowly unwound their positions… and perhaps driven some of that money into U.S. stocks that have performed superbly over the past few years.

Gold prices are down to about $1,100 per oz… down 42% from their 2011 peak

But now, gold prices are down to about $1,100 per oz… down 42% from their 2011 peak.

In fact, the price of gold hit a five-year low of $1,088 a troy ounce on 20 July, 2015 – down 4 per cent in just a few minutes after a surprise five-ton sell order was placed on the exchange by traders overnight. This, of course, triggered computer-driven “stop-loss” orders that traders had put in place to limit their losses by automatically selling gold when prices breached a predetermined level – causing prices to drop even more sharply in the computer dominated trading environment that we live in today.

What gives? And why is gold out of favor?

The Mighty Dollar: One of the reasons behind the decline has been the strong U.S. dollar which typically has an inverse relationship with gold.

Here’s the thing about gold… its price in any given currency can fluctuate as the perceived value of that currency changes. So the fluctuations in the price of gold in U.S. dollars… reflects confidence in the dollar in relation to gold. The less the perceived value of a currency, the less gold it can buy – in other words, as a currency drops in value, the price of gold goes up relative to that currency. And, vice versa, as the currency strengthens, the price of gold drops relative to that currency.

So the price of gold tends to move in the opposite direction to the value of the US dollar. And, much like many commodities, gold is priced in dollars on international markets, which means that when the dollar rises, the price of gold drops.

Interest Rates: Another related factor is the prospect of an interest rate rise in the US. Related because any increase in interest rates in the U.S. will further strengthen the dollar… and as Americans see higher interest rates on their CDs and other fixed income investments, the less they’d clamor for gold… so a rising interest rate environment diminishes the attraction of non-yielding assets such as gold. And as most of my listeners likely know, the Federal Reserve is widely expected to nominally raise interest rates later in the year – some predict September, others say perhaps around December of this year… but a rate increase is apparently imminent, barring any “black swan” events in the U.S. or abroad that we cannot foresee. And while some say the drop in China’s stock market is worrisome, most economists believe the Fed is well on track to raise rates in 2015.

Yet another factor in the drop in gold prices was news that China has been gradually selling its gold reserves, with reports that the People’s Bank of China gold bullion has dropped from an estimated 3,500 tons down to about 1,658 tons of bullion — a much bigger drop than analysts expected, which led investors to sell gold when the news broke.

Gold has also been retreating as other perceived threats have faded. So, a few months back, Wall Street was fixated on the Greek bailout… but that’s no longer a major concern so there is no flight to the safety of gold.

And while the sharp drop in China’s stock market does raise the risk of a massive slowdown in China, investors do not believe this slowdown warrants a rush to gold at this time.

Investors appear to be quite relaxed about both these events and have not sold off riskier assets such as equities and bonds.

Moreover, with stocks doing really well in the U.S. and abroad, and with gold providing neither a dividend nor any other form of income, there is an opportunity cost in holding on to it. So holding on to gold may be worth it in bad times when interest rates are low and the price of gold is likely to rise. But, with borrowing costs set to rise, commodities are losing favor with investors who can generate higher returns elsewhere.

Gold prices are also down because demand for gold has fallen to its lowest level in six years on declining orders from jewelers in dominant markets, as well as from global central banks.

Figures from the World Gold Council reveal that global demand fell by 12 per cent to 915 tonnes in the second quarter of 2015. Half of this fall was accounted for by sharp declines in jewelry demand in India and China, while central bank purchases fell 13 per cent.

So… where do gold prices go from here?

Well… frankly, it’s hard to predict where prices will be in the future… on just about anything. All we can do is sit here and make educated guesses about the future based on our macroeconomic models of forecasting… and even then, you’ll get widely different forecasts. But there’s still value to looking ahead so one can prepare for worst case scenarios or upside investment options.

So given where we are today, with a strong dollar and the U.S. economy looking up with strong job growth, low unemployment, strong housing, low interest rates and falling oil prices… gold does not hold a lot of charm and prices could still fall lower – perhaps to or even below the $1,000 mark this year. Add to this Greece’s avoiding a messy default on its payment obligations or an exit from the Euro zone for now, and a landmark nuclear deal between the world’s major powers and Iran, and you get no ‘safe haven’ support for gold either.

Now the flip side… I think gold has diversification and “insurance” value in investment portfolios… and many gold bulls believe gold is selling cheap at current levels because the world and the global economy are still very vulnerable as a whole… so perhaps, for some of you, now could be a good time to start gradually building up positions in gold because your downside now could be much less than had you gotten in at the peak… but who knows – gold could go below $1,000 OR rise back to near its $1,895 peak in the years to come. Time will tell, as always!

SOURCESFinancial Times
I've been an investment strategist and adviser for over 35 years, leading with a mission of unbiased advice to educate and protect listeners on my weekly radio show on NPR affiliates nationwide. I have been named a “Top 100 Wealth Advisor” by Worth Magazine and “Top Advisor” by Reuters.