The extended period of above average U.S. stock market returns and U.S. dollar strength appears to be in jeopardy, and as a result, gold may have reached its bottom.
While U.S. stocks have recovered somewhat from their late August rout, plunging commodity prices and declining bond yields are signaling the potential for an extended period of economic slowdown and deflated asset prices for global markets to digest. The U.S. stock market, the leading indicator of economic growth, is likely to feel the weight of deflationary forces for some time. And if the stock market stumbles, gold, the key liquid alternative asset, should be a prime beneficiary.
Support for higher gold prices also comes from the currency market, where a strong U.S. dollar remains the key holdout in a global battle of weakening domestic currencies. A stock market tumble, more Federal Reserve delays raising interest rates, or a possible shift back to easing monetary policy could be primary factors for continued mean reversion in the U.S. Dollar Index. Since the March 13, 2015 high close at 100, the U.S. Dollar Index has trended lower, despite near-universal bullish sentiment supported by increased liquidity measures from most other central banks, contrary to Fed rhetoric on tightening policy.
As for the Federal Open Market Committee’s (FOMC) take on markets—volatility, deflating commodity prices, falling stock values and declining bond yields could nudge the Fed to join most of the world’s central banks and shift focus away from restraint, eliminating key support for the dollar.
Another bullish argument for gold has been the rare backwardation in gold futures, which is often a sign of excess demand and/or slack supply. The last time COMEX gold futures were in a similar condition (first to third contract) was from December 2013 through February 2014, when gold rallied from about $1,190 an ounce to near $1,380 in March 2014.
Physical demand for gold spiked recently following the July plunge in prices, which appeared to be capitulation. And with China’s yuan devaluation, Chinese investors have been more inclined to invest in gold as the nation sorts out its stock market issues. In fact, Shanghai Gold Exchange deliveries, a good indicator of gold demand in China, are on record pace in 2015.
In India, the latest data on gold imports for 2015 shows demand running well above 2014 levels and on pace for new records. And in the U.S., mint coin sales have skyrocketed with Q3 gold sales up over 250% from a year earlier and on pace for their best year since 2011.
As investors speculate over the direction of markets, Federal Reserve policy and an extended period of above average stock market returns, gold, which has been out of favor the past few years, appears to be building a solid foundation for an extended recovery. Looking forward, investors are likely to experience increasing central bank liquidity, currency wars, sovereign debt issues and potential below average stock market returns coinciding with higher volatility levels, which should favor gold. If in the unlikely case, the stock market resumes the low volatility, above average return trend of the past few years and gold suffers, the most diversified investors will be much better off.
Mike McGlone is Director of Research at ETF Securities (US) LLC (www.etfsecurities.com).
The ETFS Gold Trust is not an investment company registered under the Investment Company Act of 1940 or a commodity pool for purposes of the Commodity Exchange Act. Shares of the Gold Trust are not subject to the same regulatory requirements as mutual funds. These investments are not suitable for all investors. Trusts focusing on a single commodity generally experience greater volatility. There are special risks associated with short selling and margin investing.
Commodities and futures generally are volatile and are not suitable for all investors.
Shares in the Trust are not FDIC insured and may lose value and have no bank guarantee.
Carefully consider the fund’s investment objectives, risk factors, and fees and expenses before investing. For further discussion of the risks associated with an investment in the funds please read the prospectus at www.etfsecurities.com/etfsdocs/USProspectus.aspx or visit the ETF Securities website: www.etfsecurities.com.