Why Isn’t Gold Responding to Uncertainty?
There are a lot of reasons for investors to seek safe havens, particularly recently. But gold has struggled to reach the $1,900/oz level. Although it could make it that high eventually, it’s still notable that it’s taking so long. There are some fundamental things going on that could explain the phenomenon, as well as some other unusual things happening in the Forex space.
The clouds are gathering
Gold bulls could compile a pretty long list of reasons to support their position. From the longer term expectation of a recession, to the more immediate worries around the “balloon crisis” between the US and China. In fact, after the US confirmed shooting down as many as four “objects” in the last few days, risk appetite rallied. The stock market rose at the expense of safe havens, including gold.
Even with the dollar getting weaker recently, gold still hasn’t managed to move up as much as anticipated. There are other, less publicized events in the gold space, such as Freeport cutting production in Indonesia due to floods. Meanwhile, China’s bought up over $5B in gold over the last month, adding it to their reserves. That was the third month of reserve growth in China, and is in line with global central banks expanding their precious metal holdings.
Prices are slowing down
So, given the fundamentals, it’s perfectly reasonable to expect gold prices to have upward momentum. But that doesn’t mean there might be some delays along the way. One of those could be the pending release of US CPI figures later today. As discussed, inflation is expected to come down once again.
Generally, gold is seen as a store of value. It’s not subject to inflation. So, in periods when inflation is expected to rise, gold generally gets more interest. But, if inflation peaks and starts to come down, that interest starts to wane. Especially in an environment with higher interest rates, which can compensate much of if not all of the losses from expected inflation.
Things are a bit skewed right now
More than gold specifically, other pricing mechanisms are in a situation that is economically irrational, for the moment. This can lead to these somewhat contradictory or somewhat erratic moves in assets, such as gold. But also things like crude, copper, and even currencies. The dollar in particular, which is the basis for pricing a lot of assets around the world.
The thing is, in normal circumstances, debt should generate a return on investment. That is, the interest rate should be higher than inflation. This is a “positive real rate of return”. The longer the debt, the more above inflation it should pay. But now, inflation is above the interest rate, meaning that anyone preserving liquidity is losing money. Buying treasuries, for example, generates a net loss. Which means investors have to look for alternatives to investment that aren’t debt.
The expectation for this year is that the Fed funds rate will remain above 5.0%, but inflation will come down to something around 3.0%. That means “rationality” in the debt markets is expected to be restored. But, before that, markets will have to adjust, which can mean situations where risk rises, but gold prices don’t, might keep happening for a while longer.