Ask 10 different investors where gold prices are going to go next, and you’ll very likely get 10 different answers, with the range of responses varying from much lower to much higher. Of course, who could blame a group of traders for all coming to different conclusions about what’s in store for gold and gold stocks like the SPDR Gold Trust ETF (NYSEARCA:GLD), or for that matter, gold miners?
The messages are mixed, and change on a near-daily basis.
When one takes a step back though, the picture is a little less fuzzy. While the extent to which the undertow could grab gold and carry it isn’t clear, that undertow is still pointed in a bullish direction.
The Near-Term View
The last few days haven’t been mild ones for gold stocks. Their primary driver — the U.S. dollar — plunged two weeks ago following the release of Q2’s tepid GDP growth report suggesting the nation’s economy only grew 1.2% for the three-month stretch.
A country’s interest rates and a country’s currency are generally well-linked, and if an expected rate hike becomes suddenly isn’t expected as soon as presumed, that currency plummets. The U.S. Dollar Index fell nearly 2% over the course of the three trading days following the release of the GDP figure, reversing what looked like a budding uptrend for the greenback while simultaneously rekindling what’s become a huge rally for gold itself. GLD is up 26% year-to-date almost entirely because of the dollar’s broad weakness.
A close look at the chart of the U.S. Dollar Index, however, reveals something else telling … as was the case in late June and early July, the 200-day moving average line (green) as well as the 20-day moving average line (blue) are now acting as resistance, hinting the currency’s bounce effort has already come to a close. With that as the case, gold prices have a bullish edge.
That’s only a short-term view, however, and the value of the U.S. dollar is constantly in question in the midst of heightened global geopolitical volatility right now.
The Long-Term View
While the dollar is the key short-term driver for gold, in the bigger picture, it’s still a hedge against inflation and currency volatility, and still subject to supply/demand forces — factors that may or may not always jibe with the value of the U.S. dollar (though they usually do).
To that end, inflation remains tame, though it rising slightly. Any rise, however, may be compelling enough reason for the Federal Reserve to go ahead and pull the trigger on a rate hike. The current team of Fed governors has more than once alluded to thinking preemptively, quelling inflation before it even has a chance to race out of control.
The irony (for gold)? Rising interest rates designed to quell rising inflation are also the same rising interest rates that help push the value of the U.S dollar up, which pulls the value of gold down … despite the fact that gold is supposed to be viewed as a hedge against inflation.
Yes, it’s an annoying catch-22, though not a new one — the conflicting arguments have always been in place. Most of the time though, there’s a clear winner and loser. (The weak dollar, for instance, won between 2005 and 2011, pushing gold prices to stunning highs even though inflation was relatively well contained.)
This time around the Fed may not be able to stave off inflation growth as easily as it has in the past, however.
See, this time, the economic rebound so far is fragile, and a firmly hawkish stance could break the much-needed recovery effort. Janet Yellen may just have to concede we’re going to be digesting a little more inflation than we’d like. That too bodes bullishly for gold prices.
Bottom Line for Gold
With all of that being said, there’s an even bigger factor to consider: raw demand for gold versus the supply of it.
The data is only supplied once every three month by the World Gold Council, and the second quarter report has yet to be posted. We do know from the Q1 report, however, that demand for gold — real consumption — has logged three straight quarters of increases, decisively snapping a downtrend that was in place during the first half of 2015. With no reason to suspect the demand trend has been disrupted since then, Q2 could mark a fourth straight rise in consumption.
Click to EnlargeSource: World Gold Council Q1 Report
Admittedly it’s tough to see how gold prices have any room to move higher… particularly with all the rate-hike chatter in the background (which could push the U.S. dollar upward with it). Take a closer listen to the tone and timbre of that rate hike discussion though. The FOMC is doing everything it can to hold off as long as it can before doing so, then keep the total number of rate hikes to a minimum. Moreover, the dollar’s heroic rise in late 2014 and early 2015 has already largely price in rate hikes that have yet to materialize.
It’s entirely possible the greenback won’t be swayed much, if at all, but rising interest rates. In that light, the biggest threat to gold prices right now — and for a while — may not actually be a substantial threat.
In other words, don’t count the gold rally out just yet.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
