Category: Uncategorized

By Mark Hulbert
Columnist

Think gold will be a good inflation hedge in coming months? Think again.

Consider: If gold GCJ9, -0.34% were a good inflation hedge, its inflation-adjusted price would be constant. Yet, while U.S. inflation (as judged by the Consumer Price Index) has declined in each month since last October, gold has risen nearly 12%. In the process, the gold-to-CPI ratio has risen markedly, from below 4.8 to nearly 5.3.

Of course, five months is a short period of time. But even over periods of several years, or even decades, the gold-CPI ratio fluctuates wildly. The ratio got as low as 1.5 in the early aughts, for example, and as high as above 8.0 earlier this decade.

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Might it be that gold is instead reacting to expected, rather than realized, inflation? It’s hard to see how that does any better job explaining gold’s recent behavior. Consider 30-year expected inflation, as judged by the 30-year breakeven inflation rate (the difference between the yields on the 30-year Treasury and 30-year TIPS). That rate has declined from 2.13% in October, according to the St. Louis Federal Reserve, to its current 1.85%.

To be sure, inflation is not the only thing that makes gold go up or down. In a recent MarketWatch column, Michael Brush listed several other factors. But inflation is, by far, the leading suspect. And you have to torture the inflation data a lot to generate a forecast that gold should rise significantly over the next several years.

Consider the study “A Golden Dilemma,” which the National Bureau of Economic Research began circulating several years ago. The study was conducted by Campbell Harvey, a finance professor at Duke University, and Claude Erb, a former commodities portfolio manager at TCW Group. The researchers proposed a fair-value model for gold that was based on the average historical ratio of gold to CPI.

That average is 3.57-to-1, based on data since gold began to trade freely in the early 1970s. The researchers’ implied forecast is that, whenever gold trades significantly above or below this level, it eventually will return to trade at that ratio again. Call it reversion to the [golden] mean, if you will.

What does this mean now? For gold to justify its current price in terms of inflation, the CPI either needs to be 47% higher or gold needs to trade for $902.

Many scoffed at the researchers when they first circulated their study in late 2011, when gold was trading above $1,700. Gold’s subsequent decline led many to take their research a lot more seriously. Unfortunately for gold investors, their study continues to imply that gold’s fair value is a lot lower than where the yellow metal stands.

It’s worth noting that the study did find an historical basis for believing gold to be a good inflation hedge. But the yellow metal does this better job only over super-long periods — measured in centuries rather than years. Over shorter periods, including periods as long as an investment lifetime, they showed that gold fluctuates widely relative to inflation.

This in turn means that it’s entirely conceivable that gold could rise markedly over the next several months. But if it were to do so, it would become even less tethered to the inflation data than it already is. Note carefully that, if that is what you’re expecting, you can’t then turn around when the CPI jumps up to argue that gold’s price should respond bullishly.

The researchers’ forecast merely is that, regardless of whether gold rises or falls over the next few months, gold eventually will return to trade at the mean of its historical ratio to the CPI.

Concerns that Turkey’s currency crisis will spill into other emerging markets — and maybe Europe — aren’t spooking investors much. Just look at gold.

It’s supposed to be the classic fear trade, something to buy when things are falling apart in the world.

But the price of gold has been tumbling.

It’s below $1,200 an ounce for the first time since January 2017 and about 13% below its peak this year of more than $1,365. What gives?

Gold does best when the US dollar is weakening. That’s when investors truly appreciate the value of gold as an alternative form of currency, not just a precious metal.

But the greenback has surged this year as the Federal Reserve has raised interest rates and is expected to hike them two more times this year. Strong corporate profits and solid economic growth have helped, too.

And gold doesn’t always do well when investors are scared.

During both the 1997-1998 Asian emerging markets meltdown and the 2008 financial crisis, the price of gold plunged, and the dollar rallied.

So as long as the dollar remains red hot, gold could continue to lose luster, Simona Gambarini, commodities economist for Capital Economics, wrote in a report last week.

“Given our view that the dollar will remain strong into 2019, we don’t expect the price of gold to recover much ground before then,” Gambarini wrote.

It’s not just gold that’s tumbling lately. Copper and other economically sensitive commodities have dipped, too. That could be a sign that investors are worried about the health of the rest of the world, even as the US economy holds up.

“Commodity prices are falling along with gold, indicating a lack of pricing pressure,” wrote Paul Nolte, portfolio manager with Kingsview Asset Management.

Rich Sega, global chief investment strategist at Conning, agrees with that assessment. For the time being, weaker emerging markets are a bad thing for copper, gold and other metals, not a reason to buy them.

“Generally, commodity prices have softened due to slack in demand. Inflation fears have been allayed too,” Sega said. Although prices are starting to pick up, few economists are worried about runaway inflation anytime soon.

And the continued concerns about Trump administration tariffs could keep copper and gold prices depressed as well.

Sega adds that gold usually tends to be a fear trade for geopolitical reasons, not necessarily economic ones. He notes that improved US-North Korea relations and a recent cooling of tensions in the Middle East have made gold less attractive.

So while panic can motivate people to rush to gold, it has to be a specific type of fear — and, for now, that fear is absent.

Gold spot futures sank more than 1%, below the $1,300 per troy ounce level on Tuesday, taking mining stocks down with them. VanEck Vectors Junior Gold Miners (ticker: GDXJ), iShares MSCI Global Gold Miners (RING), and VanEck Vectors Gold Miners (GDX) fell more than 2% each, ranking among the worst performers in exchange-traded fund land.

Morgan Stanley’s commodity team sees gold hitting $1,263/oz in 2017 and $1,258 in 2018, “a flat/benign outlook,” according to their note published Monday. Uncertain economic growth for the U.S. and China, declining trade relations and of course, geopolitical tension is expected support prices in the short-to-medium term.

Metals and mining analysts Plyush Sood and Hunter Alley updated their forecasts on large-cap miners. Sood and Alley raised their price target modestly for Newmont Mining (NEM) to $33 from $31, below its recent price of nearly $38, but left its $15 forecast for Barrick Gold (ABX) unchanged. They explained:

“Newmont: The cost guidance for 2017 was lowered by ~4% or $30/oz at the end of 2Q. After our trip, we have lowered our 2018 cost estimate to $697/oz, down $36/oz from our prior estimate, and is now at the low end of 2018 cost guidance of $700-800/oz. In our model, we have made similar cost reductions to our estimates for future years. These cost cuts raise our PT by $2 to $33.

Barrick: Our team’s gold price forecasts stay nearly unchanged. We have cut our 2017 forecasts to factor in the impact of the export ban in Tanzania, but haven’t changed our forecasts for 2018 and onwards assuming that exports can resume next year. A continuing inability to export or a value leakage in the region will affect our NAV for ABX.“

Gold remains under some pressure and as we noted here on Friday spot gold has fallen to “The Box” marking the 50-62% retracement of the move from the lows in early May of $1215 to the highs two weeks ago when spot gold traded to $1298. The Box is bounded on the low side by $1245 and on the high side by $1255 and as we write spot gold is perfectly in the “middle” of that range, with the low thus far in Asian dealing of $1250. We have to suspect that there shall be stops just under $1250 and that when those stops are elected that the lower boundary of The Box shall be put to test.

With crude oil steady at best and with stock prices generally trading better, the propensity on the part of gold buyers to rush forward is muted at best. Further, gold mining shares seem unwilling and/or incapable of 3 taking the lead and until such time as the miners lead weakness is the greater likely future.

Finally, Bitcoin is a bit weaker and we are still of the mind that the peak for the crypto-currencies generally but for Bitcoin specifically was made seven trading sessions ago when Bitcoin rose to just over $2800 and then plunged sharply, tracing out a daily “reversal” to the downside and finishing what appears to us to have been a nearly text-book Fibonacci 5 wave pattern to the upside. However, just did the EUR noted above failed to forge a weekly reversal to the downside, so too did Bitcoin “fail,” for although Bitcoin closed lower on the week it did not close below the previous week’s lows. Thus now a broader, time consuming top shall have to evolve instead. We believe it shall bit it may take time.

Gold prices traded slightly lower Friday, but futures were on track to log a second weekly gain in a row as demand for assets perceived as risky waned and as the U.S. dollar retreated to near seven-week lows.

April gold GCJ7, +0.08%  fell $2.20, or 0.2%, to $1,245 an ounce, with the precious metal aiming for a 1.3% weekly gain. Meanwhile, the commodity’s sister metal, silver for May delivery, SIK7, +0.89%  was up 4 cents, or 0.2%, at $17.63 an ounce, on track for a 1.3% weekly advance.

Colin Cieszynski, chief market strategist at CMC Markets, said that momentum for gold, which has climbed in five out of the past six sessions, may be tapering.

A pullback in the dollar which has been trading around a seven-week low, has helped assets priced in dollars to trade higher. As measured by the ICE U.S. Dollar Index DXY, -0.12% a measure of greenback against six rival currencies, the buck was slightly lower Friday and staring at a 0.6% weekly decline. A softer dollar can make assets pegged to the currency more appealing to buyers using other monetary units.

The dollar, and assets considered risky like stocks, have been stalling out after a run of records amid heightened concerns about President Donald Trump’s ability to put in place pro-growth legislation, highlighted by the president’s struggle to get the House to pass a bill that would repeal and replace former President Barack Obama’s signature health-care law, known as the Affordable Care Act, or Obamacare. A vote on the new health bill is slated for later Friday, with a failure seen by some as signaling that Trump may face headwinds on other parts of his ambitious agenda.

Gold has mostly benefited in this environment but some market strategist see the path for further rises fading somewhat.

“Gold has started to drop back as its latest rally runs out of gas,” said Cieszynski. He said a recent reading of an asset’s momentum, known as relative strength index, suggests that the recent upswing may be “getting tired” and predicted that a pullback around the $1,242 an ounce, then $1,230 an ounce, as possible.

On the economic front, new orders for durable goods climbed in February for the second straight month. Durable-goods orders advanced 1.7% while the increase in January was raised several notches to 2.3%, reflecting a pickup in manufacturing that kicked in toward the end of last year.

In exchange-traded funds that track metals, the SPDR Gold Trust GLD, +0.20% was off 0.1%, the VanEck Vectors Gold Miners ETF GDX, +0.13%  was down 0.3%, while the iShares Silver SLV, +0.72%  gained 0.1%.