When there is rampant talk about economies around the world experiencing downturns and central banks manipulating their currencies, investors think about safe havens to place their money.
Naturally, some have called for a bull market in gold.
It’s OK to be bullish on gold, but don’t expect gold prices to skyrocket and reach 2011 levels. The investment landscape has changed since then, and markets are working a bit differently. On top of that, there’s some lingering uncertainty out there that can’t be calculated into prices.
To play gold or proxies such as the SPDR Gold Trust (ETF) (NYSEARCA:GLD) going forward you have to look at how current changes — especially those in energy prices and monetary policy — will affect the yellow metal in the short and long term.
Cheaper Energy Prices
Cheaper oil typically is a key ingredient in keeping costs down in other sectors. The assumption: Shipping costs would go down, in turn keeping down the price that consumers have to pay for goods. And in such a low-inflation environment, gold looks less attractive.
However, as the market for crude oil has started to spiral with no clear floor insight, gold has actually rebounded — the fear is no longer low inflation, but deflation.
Economists describe deflation as the downturn in prices across a wide range of goods and services. Over time, this leads to lower levels of consumption, which in turns brings about lower corporate profits and wages. The belief is, just as it did during the Great Depression, that gold will hold its value during deflationary recessions.
Also, according to the International Monetary Fund (IMF), continuous falling oil prices have introduced an added risk dimension to the entire global economy. In particular, oil-dependent countries are experiencing deteriorating trade balances — that is on top of the economic outlook downgrades the World Bank gave to China, Japan and Europe.
GLD, the quintessential safe play for inflation, has also become a quality investment as protection against deflation.
Currency Wars
Last week, ECB President Mario Draghi made the announcement that the European Central Bank would begin in March to buy government bonds in an asset-purchase program worth $1.3 trillion. That was just the beginning.
The Danish central bank cut its main interest rate from -0.2% to -0.35%. It was the second time they made a rate cut in a week. Before that, Switzerland abolished the cap of the Swiss franc against the euro.
Canada created its own hysteria when it cut interest rates for the first time in almost five years. Country leadership said the plunge in crude oil prices had a profound effect on the economy of Canada — a major exporter of oil.
In all, Europe, Denmark, Canada, Switzerland, Peru and India have all recently weakened their currencies. Since the financial crisis of 2008, the global game plan has been to lower the value of your currency to stimulate economic growth.
It’s a plan they learned from the U.S.
Gold Will Be a Solid (But Bumpy) Investment
Oil prices and central bank actions are sure to dominate headlines in 2015, but remember: Both situations are fluid. The current valuations for crude oil in 2020 are around the $70 a barrel range, versus current per barrel prices under $50. So a correction is coming sometime down the road, but given that investment in production is already drying up, we could see a tailwind for prices a lot sooner than that.
Adding to the uncertainty, there is a new King of Saudi Arabia, and it’s unknown how that will affect the direction and leadership of OPEC.
On top of all of that, the U.S. Federal Reserve has promised to raise rates this year, which would make the U.S. dollar even stronger against other foreign currencies.
That’s a lot of uncertainty, and uncertainty equals volatility. So expect ups and downs in GLD, but an upward trend overall as a strong dollar buoys gold.
As of this writing, Jason Jenkins did not hold a position in any of the aforementioned securities.
