The gold price has gotten hammered in recent weeks, plunging to a four-month low of less than $1,680 an ounce on Sunday. Some analysts expect the yellow metal to keep plunging, but not everyone is convinced.
It’s anyone’s guess whether the gold price will post a strong recovery or continue to struggle.
This year’s highs brought gold to about $1,900 an ounce, but it hasn’t even approached that level in recent weeks. Analysts generally agree that the stronger-than-expected U.S. jobs report was a key driver of the weak gold price, as investors rushed to buy the dollar in response to the strong report.
Gold and the dollar are inversely correlated, which means when the greenback strengthens, the gold price falls.
Gold is also inversely correlated with real yields, which have been reacting to hawkish commentary from the Federal Reserve.
The big question is when the central bank will start to taper its quantitative easing program. With inflation running hot and jobs reports coming in better than expected, some expect tapering to start soon.
UBS analyst Dominic Schnider told CNBC that he believes real yields will “go less negative,” which means continued challenges for the gold price. He expects outflows from gold-backed exchange-traded funds and the futures markets. Other analysts agree that the challenging environment for gold will continue.
CNBC also reported that Vivek Dhar of the Commonwealth Bank of Australia said in a note that the selloff that occurred on Aug. 9 was likely triggered by Asian investors buying the U.S. dollar and selling gold in response to the previous week’s strong jobs report. Even though the yellow metal recovered some of its losses in the days that followed, Dhar said it was “difficult to remain bullish on the precious metal.”
Consumer Sentiment Plunges
On Friday, a key input for the gold price was the latest consumer sentiment index from the University of Michigan. The index plunged to 70.2 for August, a more than 13% decline from July’s reading of 81.2 and below the 71.8 reading in April 2020, which was the lowest reading in the pandemic.
In fact, this month’s consumer sentiment index reading was the lowest since 2011, and economists had been looking for 81.3. It’s very rare for the index to drop that much in such a short amount of time. The decline comes amid the spread of the delta variant of Covid-19 across the U.S.
The consumer sentiment index is a sign that the economy may not be in as good of a shape as some believe it is. Daniel Oliver of Myrmikan Capital said in a recent note that the markets are following the previous economic cycle but at an accelerated pace. He said the banks finance a bubble, and then the market crashes.
Next, the Fed prints “huge amounts of money” and “gold rips higher.” However, most of the money that was printed was in the form of banking reserves, so banks start to lend, resulting in credit inflation but not consumer inflation. Credit-sensitive parts of the economy surge, unemployment falls, the Fed stops printing and gold crashes.
The Picture Might Not Be as Rosy as Some Think
Oliver said the events over the past few weeks support his view. Unemployment is falling, but prices are rising, which means the wage increases we’ve been seeing aren’t putting workers in a better situation than they were before prices increased. He said it was no surprise that gold crashed as soon as last Friday’s jobs report was released.
Ordinarily, a strong economy is bad for gold, but Oliver argues that the economy isn’t as strong as the current employment numbers suggest. He noted that Fed Chairman Jerome Powell said the central bank’s mandate is now encouraging maximum employment over ensuring price stability. Oliver believes this suggests the Fed will simply keep printing money, which should be good for gold.
Oliver pointed out that many parts of the country have reimposed mask requirements due to the delta variant. He considers what will happen to all the jobs the economy has been adding if President Joe Biden decides to impose new lockdowns. Oliver also argued that mask mandates suppress revenue in the leisure sector, as will proof-of-vaccination requirements.
Additional Weight on the Economy
Oliver said if the government locks down the economy again or follows what other countries are doing in issuing vaccine passports that allow people to engage in economic activity, the economy would be struck yet again.
He doesn’t expect the Fed to start tapering as others do. Oliver pointed not only to the possibility of additional lockdowns but also to conditions in the real estate market. He said the Fed continues to buy $40 billion worth of mortgages every month, but despite that, the number of new single-family houses sold in June was lower than it was before Covid-19 hit.
Housing prices remain at bubble highs, although commodities have come back down after surging. Oliver said plunging commodity prices will convince the Fed that inflation is transitory, which is what it has been saying. However, he also said they would cause the Fed to worry that macroeconomic demand is waning, which means it isn’t a great time to start tapering.
Although some members of the Fed are talking about tapering sooner rather than later, Oliver pointed out that the size of the Fed’s balance sheet indicates that the pace of money printing is increasing. As a result, he said it’s no surprise that stocks are soaring to record highs, although companies are watching their gross margins shrink and being forced to raise prices.
Gold Versus the Dollar
Oliver argues that the end game for fiat currencies is when the central bank loses control of interest rates or inflation. He expects economically sensitive commodities to correct sharply as volatility is common during inflationary economies. However, he also said consumer inflation appears to have set in with no end in sight, which makes the real interest rate ever more negative.
As a result, he said the Fed would have to decide whether to “raise interest rates to chase inflation and risk market instability, or sit back and watch the dollar implode.” In either case, there will be implications for gold, and it’s anyone’s guess what the Fed will do when faced with this decision.
On the date of publication, Michelle Jones did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Michelle Jones is editor-in-chief for ValueWalk.com and has been with the site since 2012. Previously, she was a television news producer for eight years. She produced the morning news programs for the NBC affiliates in Evansville, Indiana and Huntsville, Alabama and spent a short time at the CBS affiliate in Huntsville. She has experience as a writer and public relations expert for a wide variety of businesses. Email her at Mjones@valuewalk.com.