by Claudio Grass, Acting Man:
A Strong First Half of the Year, Followed by Another Retreat
In early 2016 gold had a big bull run. The precious metal rose close to 25% this year, pushed higher in a summer rally that peaked on July 10th. Gold experienced a bumpy ride over the remainder of the summer though, as investors became increasingly concerned about a potential rate hike by the Federal Reserve. Uncertainty returned to gold market and has intensified further since then.
Initially, gold rallied sharply in 2016, but then retreated again in the second half as concerns over Fed rate hikes and the impact of Mr. Trump’s election victory have pushed bond yields and the US dollar up in the short term.
Trusting the Establishment a Bit Too Much?
Investors cannot be blamed for their skittishness, considering the misleading information released by officials. Fed chair Janet Yellen stated at the Jackson Hole meeting of central bankers that the case for rate hikes had “strengthened”, yet she gave markets little guidance on timing, saying that rate hikes would be “gradual” and happen “over time”.
This probably discouraged investors from buying gold, because they still trust the establishment and consider the Fed to have credibility. A rate hike offers investors an alternative to owning gold, as gold doesn’t pay interest. Higher interest rates also tend to dampen price inflation – which is held to be negative for the gold price as well.
But surprise, surprise! The Fed then decided the time was not yet right for a rate hike after all. The initial market reaction seemed to indicate that demand for bullion was about to revive: the gold started to rise again after the Fed’s decision to refrain from a rate hike, the dollar weakened and further monetary stimulus was implemented in Europe and Japan.
However, these are all market considerations involving short term trading tactics. This is indeed a valid and effective approach, but gold is far more than just a short term trading vehicle. We encourage investors to consider the bigger picture and to ponder gold’s long-term appeal, instead of merely focusing on short-term gyrations in reaction to the Fed’s interest rate decisions.
A System in Danger of Failing
We and many others have repeatedly warned our readers of the potential failure of the system due to the damage inflicted by the extreme expansionary monetary policies central banks have adopted. The additional money that is constantly pumped into the economy and markets ultimately poses a grave danger to systemic stability.
Central banks are now essentially in a lose-lose situation: prolonging the current low/negative interest rate environment will only expand credit and asset bubbles further and ultimately have a disastrous impact on the economy. On the other hand, raising rates will undoubtedly precipitate a severe recession as well.
They will surely try their best to avoid this, but it is an inevitable outcome. As the Austrian School of Economics warns, the longer one waits with abandoning a credit expansion, the worse the eventual fallout will be. The economy already seems to be dying a slow death. The Fed’s recent decision to once again postpone its long planned rate hike certainly shows that the central planners have similar concerns.
Recent and upcoming events pose considerable political and economic risks, with the outcome of the US presidential election being the most important. After Donald Trump’s surprise victory, it remains to be seen what his economic policy priorities will actually consist of, but among other things, he seems set on increasing government spending.
What does his victory mean for gold? Ahead of the election Citigroup’s analysts opined that “a Trump win will bring about higher volatility in gold and forex”. They painted a bullish scenario, in which gold was predicted to rise to USD 1,425 in Q4 2016.
This short term call has turned out to be wrong so far, but if the markets are correct in their assessment that Trump’s victory will boost price inflation, the medium to long term prospects for gold certainly remain bullish.
Apart from the U.S. election, there are still other potential risks lurking this year, even though they may not be making headlines in the mainstream media. For one thing, Russia apparently wants to transition its currency away from the dollar.
Russia’s government wishes to disengage from the US dollar based monetary system by adopting a “national sovereign currency”, with the aim of supporting the ailing Russian economy by severing the link between the ruble money supply and Russia’s foreign exchange reserves (the so-called Stolypin group plan).
Meanwhile, China has joined the International Monetary Fund’s special drawing rights (SDR) basket on October 1st. As a part of this basket of reserve currencies, the Yuan is on a par with the U.S. Dollar, the Euro, the Yen and British pound. This represents a milestone for China: not only has it been recognized as a global economic power, but central banks will now start to add yuan-denominated assets to their reserves.
Given that additional alternatives are now available, the popularity of treasury bonds could decline. Dollars could circulate back into the US economy, generating additional price inflation pressure in the U.S. Such a development should eventually also put pressure on the US dollar, and the Fed will then no longer have the luxury to just print money at will.
A weaker dollar traditionally translates into rising demand for precious metals, which would boost the gold market’s bull run. Recent events and data suggest that the dollar will remain strong in the near term and accordingly put pressure on gold prices. One should look beyond that though and consider the longer term implications of the developments discussed above.
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