After nearly three and a half years stuck in a bear market, gold appears to be waking up from its hibernation.
It has been a long and painful descent from its all-time high just above $1,925 an ounce in early September of 2011 to its recent low of $1,132 in early November of 2014 – an erosion of more than 41% of its value.
Yet in the 2.5 months since then, gold has been looking much like its former self, mounting a jump to a high of $1,297 yesterday for a rise of more than 14% as represented by the SPDR Gold Trust ETF (NYSE: GLD) [black] in the graph below. This beats the S&P 500’s 0% change [beige], the best performing Healthcare sector’s 4.5% gain [purple], and even the U.S. dollar’s 6.5% gain [blue] over that period.
Source: BigCharts.com
It should come as no surprise, therefore, that many analysts are once again raising their forecasts for gold:
“HSBC has raised its average gold price forecast… to average $1,234 per Oz in 2015, significantly higher by 5%,” reports Metal.com.
“Gold forecaster Sharps Pixley is sounding very bullish on the price of gold in 2015, saying it is ‘going out on a limb’ to predict the yellow metal will average $1,321 an ounce, hitting a high of $1,450 and a low of $1,170,” informs Mining.com.
“Famed investor Marc Faber, famously known as ‘Dr Doom’ for correctly forecasting market crashes and for having a perennially bearish outlook, expects gold prices to rise by 30 per cent [to $1,560] in 2015,” adds Gold-Eagle.com.
Just what is behind all this renewed optimism in gold? Is this the beginning of a bona fide come back, or just another bull trap?
Let’s start with gold’s last cycle to derive some clues from it, and then apply those clues to what lies ahead.
Why Gold Cooled
In the most basic of expectations, gold tends to move opposite currencies, not only because it is a commodity, all of which move more or less against the currencies in which they are priced, but also because gold is something of an alternative currency and store of wealth which is turned to whenever currencies get into trouble.
For instance, when the U.S. dollar was under pressure throughout the first half of the economic recovery since the financial crisis of 2008, gold soared from $750 an ounce to over $1,925 for a gain of over 156% in just three years. Two general undercurrents were behind that surge:
• The U.S. central bank’s stimulus measures known as Quantitative Easing pumped over $3 trillion dollars into the economy. Whenever you increase the supply of something, you diminish its value. This downward pressure on the U.S. dollar increased the value of gold as a safe-haven and alternative store of value.
• Another undercurrent lifting gold was the expectation of inflation, as a weak currency reduces consumers’ buying power, causing prices to rise, including the value of commodities such as gold.
But the removal of these undercurrents soon brought gold down from its lofty perch. The winding down and eventual elimination of America’s Q.E. programs meant no more downward pressure on the USD. And with still no sign of real inflation anywhere in the economy – not in consumer prices nor in workers’ wages – the fear of inflation running wild was laid to rest.
As a result, the dollar has been rising in value, ultimately diminishing the value of commodities priced in USD, including gold.
Why Gold is Warming Up
Yet lately, gold traders have been turning their attention to other regions of the world that are starting to use the U.S. Federal Reserve’s old Quantitative Easing playbook.
Japan, for one, started applying stimulus to weaken its currency as early as 2012, gradually increasing its efforts since then, resulting in a depreciation of the Yen by more than 33% from 1.284 U.S. cents per 1 yen in mid-2012 to as low as 0.849 cents per yen now.
Europe, as another, started buying corporate bonds this past November, as a means of giving corporations cheap money to keep their businesses operating and their workers employed.
But despite such central bank efforts, investors and traders alike still didn’t feel confident enough that such stimuli would really present much of a demand for gold as a safety play… until now:
“Gold had a ripper of a week last week, following a surprise decision by the Swiss National Bank to end its currency cap – a cornerstone of the country’s monetary policy,” informs Mining.com.
“We see ongoing declines in economic growth prompting central banks to fight deflation by resorting to inflationary pressures in H2,” adds Sharps Pixley.
When Switzerland’s central bank suddenly and without prior warning removed its currency’s peg to the euro last week, the world was effectively put on notice that the European Union’s main currency, the euro, is in trouble. To maintain its peg with the euro, the Swiss central bank had to keep buying euro whenever it fell, accumulating more and more euro into its reserves.
Well now the Swiss central bank won’t be doing that anymore on account of the European Central Bank’s expected adaptation of full-blown stimulus measures, widely expected to be announced following the ECB’s meeting tomorrow, January 22nd.
It’s all about that fight against deflation that Sharps Pixley referred to. As productivity slows, such as has been taking place in Europe, deflation sets-in which can seriously reduce an entire nation’s wealth. To re-inflate their nations’ wealth, central banks need to stimulate business activity and inflation by weakening their currencies, making money cheaper to obtain and loans cheaper to finance.
That is what the world is expecting the European Central Bank to announce tomorrow – full blown Quantitative Easing, the commencement of a lengthy plan to flood Europe with euros in an attempt to weaken money even more, re-introduce inflation, and spur growth.
Unfortunately for currency investors, it also cheapens their holdings, which is why Switzerland decided to cut its peg to the euro. But fortunately for commodity investors, it will ultimately increase the value of anything denominated in euro, including gold. Hence it’s recent rise.
A Balanced Approach Toward Gold
But is the ECB’s announcing of a full-blown Q.E. going to be enough to propel gold along another monumental hike up the charts like American’s Q.E. programs accomplished? Not all think so:
“We see gold demonstrating that it has turned a corner as investor flows return with a vengeance, aided by short covering and fresh longs in the futures markets,” Sharps Pixley noted.
Yet it also cautions: “Most disappointingly, though, we are unlikely to see runaway prices beyond the US$1,450 level without either significant new product innovations or without the sort of black swan events in the economy that few of us would wish for.”
While ECB stimulus will weaken the euro and raise gold relative to it, we must remember that U.S. stimulus is no more. In fact, within about a year or so (some say a little sooner, others expect a little later), the U.S. Federal Reserve will have to start raising interest rates, which will further strengthen a USD that has already been on fire for well over a year. And as the USD rises, gold generally falls relative to it.
Adding it all together – the potential of the euro weakening through ECB stimulus and the continued strength in the USD through eventual interest rate hikes – it would seem that gold should enjoy its rally a little longer, though most likely not to the dizzying heights at which it once stood some 3.5 years ago.
But then again, those “black swan” events do come by surprise, with the potential to increase market volatility and gold’s safe-haven appeal in very quick order. Hence, most money managers continue to recommend that a reasonable percentage of any portfolio be stored in gold and/or other precious metals, which would then be rebalanced as gold rises and falls in order to restore its percentage allocation.
Investing in gold in this way – as a periodically re-balanced portion of your overall holdings – will ensure you automatically buy on the dips on sell on the spikes at all times, without ever having to worry about when to jump in or when to jump out, giving you one less thing to worry about.
Joseph Cafariello
