Gold prices have fallen due to recent better-than-expected economic news, the apparent easing of tensions between Russia and the West and the probability of rising interest rates next year. Is it time to dump gold or bet that prices will increase?
Ever since gold’s dramatic correction last year, prices have struggled, as mixed, but ever slightly increasing positive, economic data indicated that the U.S. economy was slowly getting better.
But from the end of 2013 through February of this year, the mixed economic data were less positive and sometimes trending negative. Add to that Russia’s annexation of Crimea, which became the worst confrontation between the Russia and the West since the Cold War. And if that were not enough, the Federal Reserve started tapering its stimulus program, which resulted in taking the air out of the stock market and emerging markets being propped up by lots of cheap money.
Compared with overpriced stocks, gold was a bargain. Investors fled to the safe embrace of gold. Supplies were low from decreased mining and record Asian demand. When Western demand jumped, gold prices shot up.
What a difference a few weeks make. Recent economic data exceeded expectations and investors shrugged off the earlier bad data as a one-time event caused by the unseasonably harsh winter weather. The Crimean/Ukrainian conflict did not escalate into economic sanctions that hurt Russia and the West, let alone military action. The Fed continued tapering quantitative easing and went one step further by hinting at a near-term timetable for raising interest rates. Higher interest rates generally lead to a stronger dollar, which in turn weakens gold prices.
Today, investors’ fears have started to ease and gold prices have fallen as a result. Many gold bulls have begun to retreat as bears gain ground.
I’m not throwing in the towel yet and here are my seven reasons, in no particular order:
1. While U.S. economic data was generally more positive as of the past few weeks, it is in very small increments and relative to low expectations. We still have a long way to go, progress has been slow and there will be more speed bumps along the way.
2. Easing tensions in Crimea and Russia are due to the West acquiescing to Russia’s annexation of Crimea. Letting Putin keep Crimea may avoid military conflict and economic disruption today, but it pushes off a problem that only gets worse in the future.
3. The stock market is generally overpriced, and with less Fed stimulus money supporting it, a large correction or several smaller corrections might occur. Gold’s safe-haven benefits and lower prices may look more attractive like they did earlier this year.
4. Even when the Fed’s stimulus programs are completely phased out, the Fed still has to unwind the estimated $5 trillion increase on their balance sheet. No one has ever done that before. Therefore there is no history to provide guidance, especially on avoiding the unintended consequences like distorting the mortgage markets.
5. Investors have likely discounted geopolitical risks too much. The probability of a major shock to the world economy remains high. With the greater interdependence of the global markets and the speed of technology, it would not take much to quickly derail our fragile economic recovery.
6. The lack of inflation has surprised many, but the risk is still there. If the economy grows too slowly, there is a risk of deflation then hyperinflation. If the economy grows to quickly, there is a risk of high inflation. Staying on the narrow path to success depends on the less-than-nimble efforts of the federal government.
7. Gold supplies have shrunk, while Asian demand is on pace for another record high. India is starting to lift import restrictions on gold, which would unleash pent-up demand from the former world leader in gold demand. If U.S. and EU demand pick up, it is possible that limited gold supplies would boost gold prices faster.
While there are plenty of reasons to be selling gold, there are also plenty of reasons to be buying. In spite of retreating gold prices in the last few weeks, gold is still up 7.7 percent this year. That makes it one of the best-performing assets in 2014.
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