To say the past couple of weeks have been wild ones for all global markets would be an understatement. The Brexit vote has ultimately driven interest rates to multi-year lows, and though stocks have bounced back from their knee-jerk Brexit plunges, they still clearly have a valuation problem.
Meanwhile, the gold price rally that ensued following the Brexit decision finally started to weaken; the SPDR Gold Trust (ETF) (NYSEARCA:GLD) is down 0.3% today, making its performance over the past two days among the worst in two weeks.
In other words, apparently anything can and will happen, creating a maddening environment for investors who just want a grip — any grip — on any trade.
Of all the possibilities in the midst of this madness, going long on gold is the most rational one right now, for three different reasons.
The U.S. Dollar Is Weakening
One of the reasons (likely the biggest reason) for the gold price meltdown in 2014 was the rally in the value of the U.S. dollar. Between mid-2014 and early-2015, the U.S. Dollar Index ran from 79 to just over 100, reaching new multi-year highs as a result.
Problem: Gold is priced in U.S. dollars all over the world, and that strong dollar meant it could buy more gold at a certain price, thus cheapening the precious metal.
Click to Enlarge Now the opposite situation is taking shape — the U.S. dollar is weakening again.
And while the U.S. Dollar Index jumped immediately after the Brexit vote, that rally was capped rather quickly at the 200-day moving average line.
The downtrend that began in late 2015 is still intact, and it wouldn’t take much to send the index below the key 93 level once and for all. That would really offer a boost to gold.
Like It or Not, Inflation Is Firming Up
Just to be clear, a big part of the reason inflation is rearing its head again is because of the weakening U.S. dollar. It’s possible for the two to move independently though, so the inflation explanation deserves its own spot. On that note …
What’s inflation got to do with a gold price trend? It’s arguably more philosophy than science, but gold is viewed as a hedge against inflation. If it’s viewed that way by enough people (and it is(, inflation itself incites demand for gold or gold ETF instruments, in turn pushing their prices higher.
And as was noted, inflation is starting to get very real again.
Well, actually, whether or not inflation is getting ugly depends on whether or not you’re including food and energy costs. Excluding them, the annualized consumer inflation rate now stands at 2.2%, and is still rising. Including everything, cheap gasoline has kept the annualized consumer inflation rate down to 1.0%. Even so, with oil prices still mostly on the rise, there’s no reason to think any inflation rate isn’t going to keep growing.
Click to Enlarge Sensing the Federal Reserve will be able to do little about the quietly swelling inflation, gold bars and instruments like GLD are falling back into favor again.
Gold Price Levels Are Going Up
Last but not least (and an extension of the other two rationales), gold prices are apt to move higher simply because neither bonds nor stocks are in a position to do so, making gold the best bet from here.
Investment capital has no permanent home. It simply moves from one asset class to another, depending on which offers the best risk/reward scenario at that time.
Between the big three categories of gold, stocks and bonds, at least one is rallying at the expense of the third, or vice versa. With bonds reaching multi-year high values this week. It’s tough to imagine any further meaningful upside.
But, with the S&P 500 Index now valued at a frothy forward-looking price-earnings ratio of 16.4, it’s not like stocks have a ton of upside either. That leaves gold as the only plausible (relative) safe haven.
Click to Enlarge And don’t think for a minute history doesn’t show how this love triangle doesn’t at least leave one of the three pieces out in the cold at any given time.
On the chart below, it’s rarity to not see at least one of the classes rising or falling at any time.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
