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Ukraine Crisis Stokes Investor Fears

Published 08/14/2014, 03:13 AM
Updated 04/25/2018, 04:40 AM

Gold Inches Towards 10% Gain for 2014

The price of Gold has rallied recently, in light of ongoing tensions in the Ukraine. The latest shock to the markets was instigated by Russia’s attempt to deliver ‘humanitarian supplies’ to beleaguered residents of several besieged Ukrainian cities. The Ukrainians are of the opinion that all aid must be led by the Red Cross, while the Russians believe they are duty-bound to offer assistance to the pro-Russian groups in south eastern Ukraine. The Red Cross in Kiev notified the Ukrainian authorities that no order to deliver humanitarian supplies was received from the Red Cross in Russia, thereby leading to heightened tensions on the border. With fears mounting that Russia is attempting to supply munitions to insurgents, the Ukrainian Prime Minister ordered that no Russian trucks will be allowed to enter the Ukraine unless they are cleared by the Red Cross.

Safety in Gold

The price of gold climbed during the week in New York as investors scrambled to buy the precious metal following this news. During the course of the year, gold rallied 9.4% and even defied forecasts of leading investment companies like Goldman Sachs. The volatile situation in the Ukraine is but one of several geopolitical concerns plaguing the markets. The others include the on/off ceasefire in Gaza, the widespread tumult in Syria and the ongoing terror campaign being spearheaded by IS in Iraq. Viewed collectively, the Middle East and the Ukraine have given rise to increased uncertainty in global markets. By Tuesday the 12 August, the USD gained ground against other currencies. Overall, the GBP looks set to maintain its strength against a basket of currencies while the euro is likely to slide further against the sterling on the back of comments made by the ECB Chairman Mario Draghi that the euro is overvalued.

Gold futures for delivery in December gained 0.3% to $1,314.90 an ounce on the NY Comex. Barely a week ago, the SPDR Gold Trust (ARCA:GLD) dropped half a percent – wiping out the ETFs gains for 2014. During 2013, as news of US economic growth spread, the price of gold dropped 28%. The SDPR Gold Trust fund slid the most in 9 years. During July 2014, the price of gold dropped 3% owing to concerns that the Federal Reserve Bank intends to raise interest rates. It’s interesting to point out that geopolitical uncertainty will not be sustainable for gold. Regardless of the crises in the Ukraine and the Middle East, if the Fed raises interest rates, the demand for gold will drop.

The Complexity Involved in Determining the Gold Price

The gold price tends to move in the opposite direction to the mood in equities markets. When shares are soaring, people shy away from gold and vice versa. However, a caveat is in order since studies reveal that the gold price moves in the opposite direction to the stock markets less than 50% of the time. And in much the same fashion, the correlation between gold and the S&P 500 Index (over 12 months) averages 0 over the past 45 years. Much the same is true of the relationship between gold and interest rates. As interest rates rise, the gold price dips ceteris paribus. There have been several insightful econometric formulae of late that show the unique relationship that exists between interest rates and the gold price. As mentioned, there appears to be an inverse relationship between the two. If gold is to hit its glory days price of $1,900 per ounce, the yield on 10-year Treasuries will have to drop to just 1%. Of course, the price of gold is determined by more than interest rates alone – but it is an important determinant.

To substantiate the close correlation between interest rates and gold, it’s important to consider the statistical factor known as R-Squared. This is a rather simple measure which assumes a value between 0 and 1. The closer the value is to 1, the stronger the relationship. In the case of R-Squared with gold and interest rates, the number is 0.78. This represents a close relationship and it has proven (in recent times) to be accurate. There are however several other important measures that should be factored in to determine the future price of gold. These include the ratio between Gold Prices and CPI (typically 3.4:1). A ratio that exceeds that means that gold is overvalued, and undervalued when it less than that. Given the current ratio of the Gold Price to the CPI, some analysts believe that gold is presently overvalued. Of course such presumptions are merely opinions substantiated by statistics, but investors remain convinced that there are relationships between the gold price, interest rates, inflation, CPI, geopolitical uncertainty and the like.

History Dispels Many Modern Theories

During the 1970s and 1980s the interest rate & gold price relationship did not exist. As the facts substantiate, the gold price and interest rates moved in different directions approximately 50% of the time since 1969. The other 50% of the time the gold price and interest rates either fell together or rose together. Every time an investor buys gold, that investor is foregoing interest in the bank or interest-bearing securities. This is known as the opportunity cost of owning gold and it explains why gold demand falls sharply when interest rates rise.

Other factors that impact on the price of gold are the USD, oil prices and demand in Asia. 60% of the time, a weak dollar leads to rising gold prices. Over the past decade, gold has gained 255% for US investors and 273% for UK investors. When oil prices are factored into the equation it becomes apparent that there is a strong correlation between the two. Over 60% of the time, gold and oil move together which is reflective of the fact that a great deal of geopolitical tensions have arisen in the Middle East. Both gold and crude oil have gained significantly in the past decade: 235% for gold and 140% for Crude oil.

In terms of demand in Asia, it is clear that China’s appetite for gold increased during 2013. The gold price has recovered sharply from the 30% loss in 2013. Investors tend to view gold as a form of insurance and the cost of this ‘insurance’ is always at a premium when you need it most. Banc De Binary analysts emphasize that the relationships between gold and other factors are important, but a balanced perspective must always be maintained. Gold should be included as part of a diversified financial portfolio to derive the most benefit from this commodity.

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