Rising Tensions and Fears of a Stock Market Collapse Will Trigger a Gold Price Rally
As Wall Street starts to surrender to the fear of inevitably higher interest rates, it’s time to reconsider gold. And it’s best to do it now, while the gold price continues to drift in a range between $1,180 and $1,200 per ounce.
There are reasons why gold remains the refuge or safe-haven investment of choice around the world. Gold acts as the thermometer of the financial markets. When the price of gold goes higher, it means the stock market has a fever, and that a virus has attacked the economy.
After a favorable move at the start of 2018, gold started to drop, often leading it to prices below the well-established gold floor price of $1,200 per ounce.
Chart courtesy of StockCharts.com
In other words, the general view is that demand for gold for investment, or even industrial purposes, remains low. It seems that the industrial demand has been higher lately, given that electronics manufacturers have shown increased consumption—even if modest.
This implies that the lackluster gold price owes more to a failure to attract and retain investors, given that industrial demand for the yellow metal has shown only moderate increases.
Demand for gold as an investment, on the other hand, has fallen more sharply.
Irrational Exuberance Has Blinded Investors
Investors have been blinded by two related phenomena. The first is that the stock market rally all the way up to 27,000 points hinted that even traditional gold investors had no need to resort to the safe haven.
Meanwhile, even as the U.S. economy started to improve (at least according to some statistics), unemployment numbers dropped, and wages started to go up, the price of gold reflected the yellow metal’s competition with rising Treasury yields.
Yet, there can be too much of a good thing, Treasury yields have surpassed the mythical three-percent barrier, and that has sent shock waves throughout the trading floor of the New York Stock Exchange.
At this point, more than the U.S. bond market acting as a competitor to gold, an emotion has been awakened that some behavioral economists would have been right to consider as extinct: fear or risk-aversion.
Rather than boost the dollar, continuing in the old tradition of the inverse correlation between gold and the greenback, equity investors appear to have captured a bearish sentiment from the higher Treasury yields.
The Making of a Gold Price Rally
For the long-term investor, investing in gold is always a good idea. But now it has become even more worthwhile than recent memory might suggest. Gold may have finally found what it needed to begin a sustained rally.
Technically, if the dollar continues to strengthen, buying gold may not be very wise. But the European Central Bank will start to reduce its quantitative easing and near-zero interest rates, which should make the dollar appear weaker.
Moreover, since the stock market rally appears to have ended (it lost more than three percent in a single session on October 10), gold may be ready to make a comeback.
And then there’s the fact that South Africa, once the biggest gold producer, has suffered a lack of incentives to continue being so. Gold mining has become too expensive in the country, and many mines have shut down. (Source: “South Africa Gold-Mining Companies Pay High Price to Keep Digging,” October 7, 2018.)
Therefore, productivity factors are gradually holding back several tons of gold from the market. Thus, there now are two bullish factors for the price of gold: 1) what appears to be the start of a stock market correction, and 2) lower supply.
As I mentioned earlier, historically, gold has played the role of a safe-haven investment. And the U.S. economy, if not the global economy, is about to enter a period when a safe-haven investment might be necessary.
It’s astonishing that centuries have passed but gold remains a key economic indicator. Gold is still correlated to the U.S. dollar and the U.S. Federal Reserve’s interest rates.
Bitcoin has failed to dethrone gold from this function. One reason is that China and India have both banned or severely limited the trading of bitcoins and other cryptocurrencies. Demand for physical gold continues to increase in those two countries, which happen to have the two largest populations in the world.
Will Analysts Be Right This Time?
There are other factors that point to the gold price moving higher. Yes, it’s true that analysts, yours truly included, have long expected such a move.
In our justification, in the face of an unprecedented bout of irrational exuberance in the equity markets, the timing could not have been more complicated.
Fears of higher interest rates and the damage they can unleash on the debt-fueled U.S. economy have finally started to sink in. The Fed, which was playing with the idea of delaying the last interest rate hike of 2018, now has no choice but to implement it.
Treasury-yield fears will make investors more sensitive to other traditional stock market rally inhibitors like political risk. And there’s plenty of that to go around, from both domestic and international sources.
Domestic and Geopolitical Risks Are Increasing
The 2018 mid-term elections in November could set record participation levels as both Republicans and Democrats have become more entrenched in partisan positions. The appointment of Judge Brett Kavanaugh to the Supreme Court has only served to deepen the political and social divide in the United States.
It’s anybody’s guess how those political tensions will play out on the street. What is certain is that there will be more protest marches, colored by a hefty dose of divisiveness reminiscent of the Civil Rights movement of the 1960s and 1970s—except without its moral imperative.
Furthermore, investors who have been blind to the growing perils in the international arena may finally wake up to the fact that the world is a more dangerous place in 2018. U.S.-Russia tensions are at a more dangerous point than they were at the height of the Cold War. Meanwhile, Washington and Beijing are on an ever more stubborn collision course.
China Soon to Take Over Russia as Enemy No. 1?
From the U.S.-China trade tensions, only economic and political uncertainties (for the world in general and not just the U.S.) can arise.
The trade tensions will no doubt evolve into more military tensions. The fact that Washington complained and sanctioned China for buying Russian “Sukhoi Su-35” jet fighters was merely the appetizer, or the amuse-bouche if you like, of a wider struggle.
In turn, China has been expanding its influence in Africa, using interest-free loans to further displace the U.S. and others away from what is the most resource-rich continent on the planet.
Though not often reported, Washington has significant strategic interests in Eastern and Western Africa, both for resources (uranium, gold, coltan) and for geopolitical purposes (Niger, Djibouti, Mali).
Indeed, an unrulier international global order is taking shape, with President Donald Trump triggering the end of globalization. Tensions with all but a handful of countries will be the new norm. And this will gradually lead more investors to traditional safe-haven assets like gold.