Gold Prices Surge to 1-Year High on Fear Catalysts, But Can It Continue?
Gold has gotten its groove back. The king of precious metals has reached one-year highs, as investors rediscover gold’s “fear hedge” properties once more. Investors are familiar with all the scary catalysts out there, but the pressing query is whether these gold prices advances are sustainable. That depends on the timeline.
In the very short term, I think so. Gold prices are undoubtedly being largely driven by the debt ceiling and budgetary foibles in Washington, D.C. This is the “fear hedge” angle in play. Investors are bidding up gold as a hedge against the uncertainty (both economic and political) that a technical government default would bring. This includes a possible U.S. credit downgrade, dollar weakening, and slower growth.
A ratcheting-up of North Korean tensions are certainly a contributing factor. The usual bellicose rhetoric has given way to something much more sinister. Intercontinental ballistic missiles are flying over (and landing near) Japanese territory, and it seems that a nuclear test is being conducted every other week.
While we’ve seen this movie before, both situations have this “something’s going to blow” feel to it. The debt ceiling is unlike any debt ceiling negotiation in recent memory, as Trump’s presence in the White House changes all the rules. We can throw out whatever political playbook is normally followed, because anything can happen. Worse yet, it might be a desired outcome if Democrats get desperate enough to pin the fallout on Trump.
In the North Korea situation, we’ve never had a president respond with such stark cryptic warnings of action. Perhaps we’re simply not used to such rhetoric from Western leaders, but the reverberations are clearly rattling the market.
So What Happens After the Noise Fades?
The assumption is that these events will die down eventually. But that assumption presumes that these events are transitory and will pass without deleterious. But can we be so sure of that?
The debt ceiling debacle will almost assuredly be short-term in nature. But the problem is, a technical default would have lasting consequences. The full faith and credit of the U.S. government is not something that can be drummed up overnight. Nor will a credit rating agency downgrade be reversed right away. If a technical default occurs, gold should get bid up higher as the stock market takes a nasty tumble.
The same dynamic with North Korea. The rhetoric and missile-testing may play out sporadically, but the genie’s out of the bottle. The U.S. is already pressing to declare North Korea a “rogue nation” while openly beating the war drums at home. It’s not a situation that will fit neatly back into the bottle. It will require significant de-escalation before the fears about North Korea start being dissuaded.
In the near term, I think gold prices can break the four-year high of $1,362 per ounce and work their way into the $1,400-per-ounce area. Especially if the debt ceiling negotiations go to the wall. North Korea will continue to pepper the news cycle. The only caveat is if the debt ceiling negotiations lead to a solution before the technical default. Gold could easily experience some near-term relief selling.
Chart courtesy of StockCharts.com
Longer term, I love gold at the later stages of the next recession. That’s when it’s likely that the Federal Reserve will reverse its balance-sheet tightening and open up the printing presses once again. Interest rates will probably come down. Gold has responded mightily on this dynamic in the last two recessions, and I expect it will happen again.