Higher inflation, increased geopolitical tensions, escalating trade disputes — all of these factors normally would be fodder to take gold prices higher as investors would seek a safe haven for their money.
But gold prices are down nearly 8 percent on the year and are at their lowest level in more than a year. Gold’s weakness has left some market watchers to scratch their heads. Inflation is normally gold’s favorite food as the yellow metal is seen as a store of value during times of rising prices, but metal seems to have no appetite. Higher inflation is seen in stronger consumer price index data, which showed the CPI up 2.9 percent in the 12 months through June, the biggest rise since February 2012, after advancing 2.8 percent in May.
Analysts at Commerzbank say in light of the numerous risks facing investors, such as international trade conflicts with China, Europe and other countries, political crises in both the U.S. and Europe, dispute over Iran sanctions, high-priced stock markets, there is no justification for the weakness in gold prices.
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“We no longer understand why gold should be sold to such an extent,” says Carsten Fritsch, analyst at Commerzbank, in a research note. “Concerns about an escalating trade dispute and fears of an economic slowdown in China should normally argue in favor of gold — not against it. What is more, the fickle U.S. president … highlight(s) the inherent political risks that currently exist.”
What’s keeping gold from rising at the moment is a stronger U.S. dollar, market watchers say, as the U.S. Federal Reserve raises interest rates. Because gold is denominated in dollars, the yellow metal has an inverse relationship with the greenback, falling when the dollar is rising. If the dollar keeps its dominance gold will continue to wallow. But analysts say given gold values are at such low levels, it won’t take much for gold to regain its shine if the dollar stumbles.
Factors driving gold now. Rob Haworth, senior investment strategist with US Bank Wealth Management in Seattle, says “it’s been an interesting time for gold,” given the backdrop of geopolitical tensions that normally would underpin prices.
But the Fed’s interest rate hikes and rising rates are driving gold prices right now.
“Even though inflation is picking up, so is the real rate of interest,” he says. “Why that’s important is it creates competition for gold, meaning the opportunity costs for gold investors is getting higher and higher.”
The yield on the U.S. 10-year Treasury note is 2.96 percent, up from 2.24 percent a year ago. Since gold has no yield, investors who hold the metal for safety reasons are missing out on the yield now offered by U.S. Treasury notes, also seen as a very safe investment.
A stronger U.S. economy and still-high U.S. stock market give investors little reason to buy gold, either, Fritsch says.
Haworth says as gold falls, investors who use price charts to track gold’s movements think the price trend is lower based on these technical charts. That’s convinced some investors to make bets on further price weakness by selling gold in the futures market, known as taking a “short” position. Haworth says Commitments of Traders data from the Commodity Futures Trading Commission, the government oversight agency for the futures market, recently showed speculative investors have a net short position for the first time in more than two years.
“Sentiment has really changed as well,” Haworth says. “If you look at where we are compared to two years ago, it’s not that the geopolitical risks have abated at all. It’s entirely down to the fundamentals of this market, which is what’s happening with the real (interest) rate, what’s happening with the dollar.”
Fritsch says weakness in base metals, like copper, may be indirectly affecting gold. The trade barbs between the U.S. and China have hit industrial metals often used in building materials, and China is a major buyer of industrial metals. China’s economic weakness and falling yuan are taking a toll on base metals prices. Fritsch says investors might be selling gold to offset losses in other commodity sectors.
[See: 8 Ways to Buffer Your Portfolio From a Market Slide.]
Richard Baker, editor of The Eureka Miner, a metals newsletter, notes gold and the yuan have moved in lock-step since U.S./China trade tensions started escalating in March. China is a top global gold buyer with both its central bank and citizens keen purchasers.
“Currency devaluation is certainly in the PBOC (People’s Bank of China) tool box to combat U.S. tariffs, the problem is how to do it without initiating capital flight,” he says. “Their central bank may be calculating that a gold-based ‘soft’ devaluation is the best way to minimize capital leaving the country while delivering an effective trade counterpunch.”
The outlook for gold. Much depends on the dollar’s direction. Bart Melek, head of commodity strategy at TD Securities in Toronto, says the bank expects the greenback will lose steam. “Recent statements from President (Donald) Trump accusing America’s trading partners of currency manipulation and his break with tradition to criticize Fed policy provides a catalyst for fundamental factors,” Melek says, commenting on Trump’s tweets complaining about rising interest rates.
He also says as the U.S. yield curve flattening, where short-term and long-term rates are at similar levels, will be a major headwind that start to work against the dollar.
Then there’s the likely changes with other central bank’s monetary policy, says Bernard Dahdah, analyst at Natixis. The European Central Bank is expected to announce monetary policy normalization in September. While the ECB may not begin to raise rates, it may no longer engage in quantitative easing, which could support the euro.
With this backdrop, Melek has a three-month target for gold prices at $1,280, and Natixis sees gold prices averaging around $1,260 for the rest of this year and average around $1,310 in 2019.
[Read: Commodities Have a Bullish Outlook for 2018.]
Yet Haworth doesn’t think the changes in ECB policy will make much of a difference, and he says the Bank of Japan is continuing with its quantitative easing monetary policy. That should mean U.S. interest rates will remain attractive relative to European rates. Plus economic growth here is stronger, another support for the dollar.
“The U.S. economy is generally still on stronger footing than what we’re seeing in Europe and another major global economies, and is getting stronger, mostly because of the tax cuts here,” he says.
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What’s Behind Tumbling Gold Prices? originally appeared on usnews.com
