Gold’s 18% move in January had the masses calling for a correction. And fair enough – sharp price moves like that do usually give up some of their gain. Forecasters pulled out every tool, from technical support levels to Commitment of Traders data, to predict a considerable step back.
But that’s not what we’ve seen.
Gold has now spent two full months trading between US$1,210 and US$1,270 per oz. The lowest point of that range still has the yellow metal up 12% compared to the start of the year.
Instead of correcting, gold is consolidating. You can think of that as correcting through time rather than price. Doing so proves the move was valid.
Gold equities have also held their ground.
Importantly, both the GDX and the GDXJ are holding above their 50-day moving averages. But as the indexes consolidate, the averages are catching up. That matters.
With any stock or index, a big gap between the 50-day moving average and the current price suggests an overbought situation. Oftentimes that means the price is heading down, but sometimes the price will hold and allow the 50-day average to catch up. The latter should happen when the move was valid – when there were fundamental reasons behind the gain.
Gold equities are one such case. As it becomes more and more apparent that the broad US bull market is over, investors are searching for value. Commodities are one of few sectors that completely missed the bull market party, which means they offer what these investors seek: undervalued opportunity.
Generalist investors turning to commodities in search of value are not generally the type to take 5 or 10% gains. They are positioning for a bigger move. That is why gold equities are holding their ground, not correcting despite their biggest gains in years.
Technical analysts would describe the current gold, GDX, and GDXJ charts as potential “bull flags”, which describes a consolidation between two big moves up. The second move still has to happen before the flag is confirmed, of course, but the situation is setting up.
Why would gold gain again? This is a topic that has seen much discussion, in these pages and others. I will not dive into all the details today but will focus on what I think is the most important factor: interest rates.
It was only a few weeks ago that Janet Yellen shied away from an interest rate raise. Gold’s sideways pattern since then has some people asking: Is the safe haven trade dead? Shouldn’t gold have gained for longer?
The answer is no, because the market’s fixation on interest rates means the decision was factored in very quickly and traders immediately moved on to the next question: What will the Fed do next?
To answer that, we need to weave together economic realities, how the Federal Reserve makes decisions, and market performance, and then add in a sprinkle of politics.
The global economy remains weak. Global growth just keeps slowing, hindered by both developed markets like Japan and emerging economies like Brazil. World trade is shrinking. The US is on tenuous footing, with corporate earnings declining, energy sector defaults imminent, and manufacturing in recession.
All of this matters to the Federal Reserve…a bit. The Fed is very focused on unemployment, inflation, and GDP growth. On the first front, unemployment is low (if you cast aside important details about underemployment and part-time work). Lots of people working supposedly means inflation is coming. It was to get ahead of that coming curve that Yellen raised rates in December.
Unemployment is still low…so why didn’t Yellen raise again? Because reality caught up. Markets tanked in January, on the expectation that the Fed would continue tightening. The markets like easy money, not tightening. The crash was enough to change the Fed’s course – because even though market performance is not actually a Fed mandate, market performance is seen as a Fed goal because markets reflect economic performance.
Even though markets had mostly healed before March 16th, Yellen could not tighten against a market that had recovered because it no longer expected tightening. A raise would have undone the upswing.
Now the question is: what will happen in June? The Fed will be looking at those ‘good’ unemployment numbers. It also desperately wants to raise to create a cushion of possible cuts should the US economy stutter. And it may be problematic to raise in September, because a rate move so close to the presidential election would spark endless controversy.
So a raise in June looks likely.
But it is not guaranteed. Since they met in mid-March the members of the Federal Reserve Open Committee seem to be trying to spread expectations as wide as possible, with some members giving highly hawkish speeches while others duck and dive.
So perhaps no raise.
The good thing, though, is that gold should do well in either situation.
Here are our two potential paths.
- Global economic growth is enough to avoid disaster. Easy monetary policy in Europe, Japan, and various emerging markets supports stock markets. Relative strength means United States can continue to normalize, starting with a rate hike in June.
- Global economic growth stalls and fails. Central banks in the EU, Japan, and emerging markets have no ammunition to fight the slide. The United States gets dragged down and implements rate cuts and quantitative easing, rather than tightening.
The former situation suggests inflation while the latter suggests deflation. There is only one asset that does well against fears of both inflation and deflation: gold.
Most importantly, gold performs best when investors are uncertain.
Uncertainty – are we headed towards a recession or not? Is the US bull market over? What is going on with oil? Are US-dollar emerging market debts serviceable? Will energy sector defaults drag the market down? Will Trump be president? – All of this uncertainty should be great for gold.
Gold is a hedge against the unknown. And there is a lot right now that we just don’t know. We don’t know how negative interest rates will play out. We don’t know what the long-term impacts of quantitative easing will be. We don’t know whether unprecedented central bank support actually fixed the problems of 2008 or just papered over them.
The broad nature of this uncertainty has in recent months translated into broad-based interest in gold. Clients from all different backgrounds have been buying gold and gold equities. The safe haven play is very real and very much in action; the current pause is part of the process.
In time, we will end up on one path or the other.
If it is path #1, investors will continue to buy gold as a hedge against inflation. There will also be a significant group that remains unconvinced about the recovery for a long time; this group will also buy gold.
If it is path #2, investors looking to escape the risks that stem from deflation (debt defaults, currency debasements, equity losses) and those simply looking for safety and value will buy gold.
So, if you are a long-term investor you may want to consider accumulating positions in high quality gold equities.
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