Predictable and Short-Sighted Analysis Explains the Drop in the Gold Price
“The measure of intelligence is the ability to change.” This quote is attributed to Albert Einstein. There are many doubts about its veracity, but it does make some sense. Certainly, it makes more sense than the gold price.
The gold price has been falling. It has lost some five percent in 2018 since the peaks set not that long ago in April. So, what has changed? Or, rather, what’s happening?
Simply put, investors follow a tired Pavlovian pattern. They have not changed their opinion, continuing to trust tired formulas without examination.
The Pattern: Higher Dollar, Lower Gold Price
What this simplistic analysis says about most investors is that they are either all blind, deaf, and mute—or they are all dangerously misinformed.
Rather, rapidly accumulating risks knocking at the door of global politics and the markets should have prompted many to rush for safe havens like gold.
The bearish argument for the gold price derives from clearly conflicting factors. The media, of course, have played their part, emphasizing inflation and job growth numbers without so much as a single skeptical consideration.
The Federal Reserve bankers are saying that inflation is coming—and there certainly has been an inflation of energy prices. But the excessive importance given to inflation has encouraged investors to eliminate gold from their portfolios.
Gold, the safe-haven asset par excellence, has been put aside because of the fast-rising dollar.
The Federal Reserve’s premature interest rate hikes, meanwhile, are used as an excuse to sell gold.
Investors Aren’t Paying Attention to the Risk Clouds Over Wall Street
The damage that these very same interest rate hikes could cause the financial markets is ignored. Higher rates will reduce risk appetite. Many investors, who borrowed to invest on Wall Street, will be forced to pull out of stocks.
Then there’s an ever more volatile global situation to consider.
The U.S.-North Korea summit in Singapore on June 12 may have sent an optimistic message of potential peace. Meanwhile, the market effects in the mid and—more importantly—longer term are far from clear (or bullish).
That said, investment in gold or any other asset does not follow logic, at least not at first. Logic says that gold prices should be higher.
Eventually, the gold price will be forced to reflect that risk. But it’s always in hindsight.
After all, in any speculative situation, it’s always a handful of people who win. The majority lose because they follow the majority’s mediocre thinking.
Still, as the quote at the start of this essay suggests, intelligence and the ability to change opinion do have some correlation, regardless of whether Einstein or Joe Blow said it.
What’s Motivating Investors Now?
Let us then consider the logic that the gold price is following now.
The gold price per ounce is dropping. In the short term, expect it to fall below $1,267. It has not found the new floor yet. And it could go as far down as $1,200 if the rhetoric on inflation and interest rates persists.
The essential ingredient spoiling the soup for gold remains the alleged strength of the dollar. That perception has gone unchallenged, even if Russia and China are dumping their dollar-denominated debts. The possibility of a global trade war has turned into the probability of one.
Thus, for the time being, stock prices on Wall Street appear stable, softening the appetite for gold. The bears have forced their way through.
There is good news, however. The situation has made gold cheaper to buy.
It’s unclear how low the gold price could go, but the time has come for those who may wish to add more of the precious metal to their portfolios.
The FOMC Factor
The Federal Reserve came out of its June meeting having raised interest rates to 1.75%–2.0%.
Perhaps more indicative of the bearish sentiment on gold is that the 12 bankers who make up the Federal Open Market Committee (FOMC) have recently all but confirmed the rumors of four interest rate hikes rather than three—as Chair Jerome Powell said last February.
That aspect may be driving the gold price toward the $1,200-per-ounce level. How fast could it go there? That’s the next big question. A slow retreat is unlikely because the risks affecting the world economy now are accumulating at a pace that defies the media’s ability to grasp.
Moreover, nobody appears to have considered how rising interest rates will affect economic growth. Normally—speaking of Pavlovian reactions—higher interest rates are supposed to trigger slowdowns or recessions.
In theory, the gold price should get some support coming from China and India, where there’s always demand for gold from jewelers.
But the dynamics for this market depend on the overall course of the economy as well. The lower price dynamic could favor demand, however. And that could prove to be a sufficiently important factor as to push the gold price back toward the $1,300 mark.
Therefore, investors should not rely on a sudden gold bull run. The best that gold price bulls can expect is volatility.
Potential Weakness of the Dollar
As explained above, the main factor behind the drop in the gold price is the dollar. The U.S. currency has gained considerably against its major rival, the euro.
But this more reflects European or eurozone weakness than it does American strength.
And this is one of the main risk factors for the gold bears.
The euro has been dropping because of problems deriving from a growing dissatisfaction from the southern and central European Union (EU) states. The main cause of trouble has been the uncontrolled or illegal migration phenomenon from Africa.
But Italy, at the epicenter of euro-skepticism, has a new government, which has an electoral mandate to stop the flow of illegal migration.
So far, Italy has secured German support for an overhaul of the migration rules. And the topic will be at the heart of forthcoming EU summits.
There’s a good chance that European leaders will finally find some agreement to block the non-governmental organization (NGO) ships operating near Libyan territorial waters. Their presence encourages migrants to take the risk of attempting to cross the Mediterranean on makeshift boats.
If the EU can agree on migration, they will be able to shift some attention to the financial and economic problems that persist, despite a slow but steady recovery from the 2008 financial crisis.
Even if success on either problem takes time, the mere hint that EU member states can agree on something will help restore confidence. This could cause the euro to gain on the dollar.
And Then There’s Korea…and Syria
The gold price went up whenever President Donald Trump and North Korean leader Kim Jong-un exchanged words before their historic meeting in Singapore.
The perception of peace has been somewhat exaggerated. Certainly, for the time being, it appears as if a war between North Korea and the United States has been averted.
Many people, including some analysts, have short memories. North Korea is merely one of many significant geopolitical risks.
The media has forgotten Syria and it has certainly forgotten Iran, which has every reason to resume research into the development of a nuclear weapon.
American troops remain in Syria. While the Russian- and Iranian-backed Syrian forces have made considerable progress in restoring Damascus’s control, there’s always the risk of a skirmish involving Russian and U.S. troops.
Russia is hosting the 2018 FIFA World Cup now. The country wants the event to go as smoothly as possible, avoiding any potential situations that could bring the wrong kind of attention from Western media.
But all it could take for geopolitical risks—and the gold price—to go up is an allegation (even an unproven one) of chemical attacks.