Gold goes up in times of economic uncertainty. It’s the ultimate form of insurance.
I’ll bet you’ve heard that hundreds of times.
What you’ve probably heard less often is that gold goes up even when there isn’t any economic drama fuelling the price.
That said, right now, the yellow metal is having a tough time.
Even though there was a price spike to a yearly high of US$1,355 (AU$1,767) in September, the yellow metal has had an ordinary trading year. For the year to date, gold is up 9.5%. Which pales in comparison to the Dow Jones, up an incredible 24.7% in the same timeframe.
Not helping the metal’s woes are all the fund managers jumping out of their gold trades. Check this out:
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Apparently, hedge funds have no interest in ‘safe haven assets’ like gold. The incredible rally in US stocks this year is where the money managers want to be. And there’s no doubt the sudden rise of cryptocurrencies is capturing their attention too.
Of course, when you manage other people’s money, it makes sense to invest where the gains are.
But I believe all investors should have a small exposure to physical gold. As does Joe Foster, manager of VanEck International Investors Gold Fund, who told Bloomberg yesterday:
‘Nobody cares about gold right now. With the stock market marking new highs, everybody’s talking about bitcoin, nobody needs a safe-haven asset in this environment. But I think it would be foolish not to have an allocation to gold because it has a very low correlation to stocks and it’s a hedge against systemic financial risk.’
No doubt this mass exodus is pressuring the gold price.
Traditional gold market faithfuls aren’t buying as much gold either. India — the second largest market for gold — has seen imports drop for the third month in a row.
In the US, the usually paranoid coin collector market is easing. Monthly coin sales have dropped 23% from October to November this year.
There are possibly two reasons for gold’s run: the potential effect of Trump’s tax cuts and, more importantly, the association that rate increases mean bad news for gold.
The Federal Reserve Bank has raised rates three times already for 2017. Markets are already placing bets on whether there’ll be three or four hikes from the Fed in 2018.
Yet rising interest rates are good for gold. Now, the gold price often spikes higher during market turbulence. But steady periods of calm can also cause the price to rise.
The difference is that when the price rises during a calm market, it tends to be a slow and steady increase. Let me show you what I mean.
Take the 1970’s Arab oil embargo on exports to the US. This move caused a shortage of oil in the US, hurting its economy and driving up inflation.
Yet have a look at what happened to the gold price chart below. The first red arrow on the left tracks the price of gold during the 1970s. From 1973 to early 1980, the gold price rose from US$65 to US$665…an incredible 923% gain.
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Then there is the more recent gold bull run most investors are familiar with.
A decade ago, the world got a glimpse of how layered financial markets are. The near collapse of the banking system was felt everywhere. Suddenly, complex financial instruments with no physical assets backing them were topics no longer limited to corporate boardrooms.
It’s no surprise, then, that the next big price spike for gold started in 2007. The rally continued until the end of 2011. Starting at US$665, the price of gold peaked at US$1,805 an ounce. This is the red arrow on the far right — a period when gold gained 171%.
Therefore, gold rises during periods of uncertainty — something we already know.
Yet, you may have noticed the black circle between 2004 and 2008…a period of relative calm and bullishness in global markets.
Many people assume the price of gold only rises in times of economic uncertainty.
In other words, if everything is fine, gold has nothing to react to. Therefore, rising interest rates should cause the yellow metal to fall.
But that’s not necessarily true. Do you recall the black circle on the gold price chart above? The one from the calm period between 2004–08? Let’s have a look at what happened during that time:
Source: Sprott and Bloomberg
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What you see here, shown by the yellow line, is the gold spot price from June 2004 through to June 2006. Over this two-year period the yellow metal climbed 62%, from US$385 per ounce, to US$625. It peaked at US$730.20 in May 2006.
Check out the red line. This represents each meeting where the Federal Reserve Bank met and increased the cash rate at every single meeting over a two-year period.
During this time, the Fed raised rates from 1% to 5.25%. Yet the gold price still rallied.
Granted, the yellow metal didn’t surge like it does during times of turmoil, as in the 1970s or during the financial crisis.
But this chart shows us that gold can — and usually does — go up in the face of rising interest rates.
This calm period shows what is possible for the price of gold.
History may be getting ready to repeat itself.
Remember, nobody notices the price of gold when it is climbing steadily.
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