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There are many opposing views as to what will drive the
price of gold this year and in which direction. We will discuss these views
and the major factors that have contributed to their formation. Gold is a
function of monetary policy just as currencies are, so we will cover on the
actions and current stance of major central banks with a heavy focus on the
Fed and the US economy. We currently hold the view that the Fed will hike
this year and that this will drive gold to new lows before the end of 2015.
US Economy
Since the global financial crisis in 2008 the US economy
has appeared to be on the road to recovery, only for its health to decline
further. These false starts show that the current growth and apparent
economic health in the US may not be the beginning of another boom. If this
is the case the Fed will have to delay the first rate hike, which will be
extremely bullish for gold.
However, the signs are particularly strong at present.
The employment sector has shown consistent growth with considerable gains in
nonfarm payrolls. The average gain of 268,000 jobs a month over the last
twelve prints has led to unemployment declining towards the Fed’s target, and
has thus resulted in many holding the view that 2015 will see the beginning
of a new tightening cycle.
From a trading perspective we believe the current
situation is one of “the trend is your friend”. This means that we would
rather react to a change in data or waning of economic momentum than to call
that the economy is heading south prematurely. Moving against the tide of the
US economy has been a losing battle for gold bulls in recent years.
The Fed
Gold bears and the majority of investors in the markets
both believe that the Fed will hike this year. We are among these, with the
June meeting being the most likely candidate for a hike being our view. Just
as massive quantitative easing and accommodative monetary policy was highly
bullish for gold, a rate hike and an overall tightening of policy will drive
gold lower. This means that if data continues to show improvement in the
economy, then the Fed will hike this year and gold will be driven to new
lows.
Although if recent strength is simply another false start
and the data takes a turn for the worse, then the Fed will delay the start of
a new tightening cycle. In fact, if the situation becomes severe there is the
possibility that the Fed may introduce new easing measures. A dovish change
in stance from the Fed, by way of at least a delay in tightening, would be
highly bullish for gold.
The Fed has been building towards a rate hike ever since
tapering was first discussed, which means that they have now been on this
course for years. The situation in the economy also appears strong enough to
support higher interest rates and is likely to continue to show improvement.
We therefore believe it is near certain that the Fed will hike rates before
the year is out.
Monetary Policy Globally
Gold is a function of monetary policy, which is why we
cover actions of central banks closely in our research. However, the Fed is
not the only central bank, even if it is the most influential to the gold
price. This means that we must also consider the actions of central banks
globally.
Outside of the US monetary policy is still highly
accommodative. The BOJ and ECB have both embarked upon new, major
quantitative easing programs in the last six months while other countries are
cutting rates or at least holding back in increasing them. This provides a
positive back drop for the gold as an alternative monetary asset that cannot
be simply “printed” to ease economic conditions.
Yet in spite of this accommodative policy, the fact of
the matter is that gold still remains very close to the lows made last
November.
The argument that we as gold bears hold as to why ECB QE has failed to drive gold higher
is based on the nature of the QE, which targets credit rather than simply
being broad based. This means that it will stimulate growth in a similar way
to QE3 in the US, which history shows was highly bearish for gold.
The action from the BOJ has not sparked any major
movement higher either, but for a different reason. This is that markets and
come to expect accommodative policy from Japan after years of deflation and
the efforts to combat it. This has lessened the impact on the gold price to
effectively nil, which means that future action is unlikely to spark a rally
either.
This means that although the actions of central banks
globally may provide a positive back drop for gold, it does not make sense to
be holding the metal. There are other strategies, such as selling downside equity protection and
being long stocks, that are much better suited to taking advantage of
accommodative monetary policy.
Currency
Monetary easing across most of the world means that the
currencies of these economies, such as the Euro and the Yen, are likely to
weaken. This is bullish for gold since the metal makes a good investment as
an alternate currency for those in the Eurozone and countries with an
accommodative stance.
However, there are also bearish currency implications
that arise from the Fed moving towards a tightening cycle while policy is
still dovish across the rest of the world. The US dollar has strengthened
significantly with a rate hike has been priced in while other currencies are
being weakened.
This strength has slowed upward movement in the gold
price and is likely to continue to do so. A strengthening US dollar also
means that even if gold stays at its current level in other currencies, it
has the potential to decline in US dollars.
We believe that the currency implications are on the
whole bearish for gold. It is unlikely that increased demand for gold as an
alternative monetary asset will counteract the strengthening of the US dollar
and the bearish effects of the Fed moving towards a tightening cycle.
Oil
Oil has more than halved since June last year and has
lost a third of its value in the last three months alone. This decline and
the resultant low energy costs are arguably yet to flow through to effect
inflation in full. This means that disinflationary risks are still present
with the potential to delay a rate hike and push gold higher.
There is also the risk that oil breaks lower again and
declines significantly form here. This leads to the possibility of
disinflation and new QE programs in the US to combat it. The effect of which
would be massively bullish for gold.
Oil prices have stabilised somewhat around the $50 level,
which means that there is the potential for an increase from here. Given that
this is the case, we believe the Fed will look through the drop in energy
costs as “transitory”, just as they did when oil prices rose post GFC. Policy
is about much more than the price of oil and as such linking Fed policy with
such high leverage to energy costs is a misconception.
Inflation
The key risk to a bearish stance on gold is a change in
the trend of economic data in the US. At present this data is showing
improvement in the US economy, particularly in the employment sector as we
have covered, but there should be at least some concern around prices. There
has been a lack of wage push inflation and the overall inflation rate has
slowed since reaching 2.1% in June last year, with the last print showing only
a 0.8% rise in prices. If this continues, then the Fed will be under less
pressure to increase rates and therefore may delay the first rate hike and
lead to a rally in gold.
Although lower inflation does pose a risk to gold shorts,
it is unlikely that this risk will become a reality. We are beginning to see
wage inflation that is likely to increase as the unemployment rate declines
further. Oil prices have also begun to stabilise and have the potential to
rebound from here. This means that the current situation in inflation is
likely to be transitory and not indicative of the overall economic health in
the US. Therefore, it is likely that inflation will provide sufficient
pressure for the Fed to hike this year.
Conclusion
Considering the factors and dynamics discussed we are
bearish on gold. We respect the risks in play and believe that the extent of
the Fed’s hiking cycle will be less than the market currently anticipates,
but that ultimately the effect will be bearish. We hold the view that the Fed
will hike in June and that ahead of this gold will suffer significantly.
Specifically, we believe that gold will make a new low and trade beneath the
$1130.40 level seen last November and are offering a money back
special
to new subscribers until March if
we are wrong. To find out how exactly we will take advantage of the decline
in gold, please subscribe below.
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