The roller-coaster ride for gold has continued this week, falling to almost $4,100 on Monday, but bouncing back to just below $4,500 since then. Some traders might be wondering if it will settle at this point for now, while others wonder if it’s just a dead cat bounce. Has gold touched bottom, or is there more to go?
Gold has lost 20% since its most recent all-time high, which means it officially has entered a bear market. This is a peculiar development for an asset that is presented as a safe haven from crises like the one markets are going through amid the war in the Middle East. So, why is it different this time, and what does that mean for the future of the yellow metal?
Too Much of a Good Thing
Earlier this year, gold prices shot as high as $5,594.82, the current record. It was the culmination of the price nearly doubling over the prior 12 months, the fastest increase in at least fourty years. But those gains, particularly at the tail end, were driven in large part by speculators, attracted to the gains that gold had already posted.
In other words, gold prices had probably risen too high, too quickly at the start of the year, and, in fact, had a correction even before the war began. That doesn’t mean that the overall tendency for gold still isn’t to the upside. After all, gold is also a hedge against inflation. It just means the market got a little carried away.
So, Buy the Dip?
If gold is a good store of value when there is high inflation, why isn’t it going up now that everyone fears that crude prices will push up inflation? Well, that’s because it’s uncertain. Meanwhile, interest rates are more certain. Traders can now buy Treasuries at higher yields than before, as investors expect higher future interest rates. Since gold doesn’t offer any yields, higher yields in Treasuries are comparatively more attractive.
The war might be over at any minute, and crude prices might fall. So, inflation might not materialise, and buying gold might not be such a good investment. As the war continues and inflation becomes more inevitable, investing in gold to offset it could become increasingly attractive. Particularly if yields remain steady, because they jumped in anticipation of a worst-case-scenario in the war.
What Else Is Driving Down Gold?
The massive selloffs in markets, particularly in Asia, have meant that traders have needed liquidity to shore up their portfolios. And what they are more likely to sell are “winning” trades, like gold, which is still up over 80% from around a year ago. Gold is more likely to decline amid a general market retracement, simply because it’s risen sharply over the last several months. Traders can shore up their portfolios by taking profits in gold and other precious metals, such as silver.
The difficulty in determining whether gold has hit bottom is that it largely depends on the risk around the war in the Middle East. And that’s not something that maybe even the leaders of the US, Israel and Iran can know at this point. A quick resolution of the war could lead to a quick rebound in gold, while a prolonged war could lead to gold recovering over time as markets price in higher inflation and as equities underperform. But gold could remain under pressure until either of those scenarios is certain.
Oil price reactions to a potential de-escalation in the war will be covered tomorrow. Read more in Fundamental Analysis.