Gold rallied in excess of $300 from the bottom to the recent, post-Brexit top. Now what? That is a good question. First let us look at the conventional wisdom as to why the gold price has been behaving the way it has.
The main impetus for the surge in gold prices this year is the expectation that more central banks will be moving towards negative interest rates. Some commercial banks have already imposed negative interest rates on deposits, creating an incentive to invest in gold. Also, the specter of Brexit brought uncertainty to the markets; as a result, investors have been looking for a safe haven to park their funds. Gold has always been a safe haven.
When we view gold relative to other commodities, we find some interesting comparisons.
During this rally for example, gold has never been more expensive when priced in terms of oil. The gold price in February hit an all-time high at around 47 times the price of oil. The previous high was 41 times the price. For perspective, the ratio was at 6.6 in June of 2008. Even though the ratio has since come down to 28 times higher, it is still a noteworthy development.
In 2008, platinum was at a premium of over $1200 above the price of gold. Late this past winter when the gold rallied and the platinum couldn’t get traction, platinum traded at a $300 discount, a new all-time low for platinum against gold. Gold is now trading at a $220 premium.
In 2011, when both silver and gold moved to historic highs, this relationship stood at around 32:1 or 32 ounces of silver relative to an ounce of gold. This winter, the silver-gold ratio traded at around 84:1, though now it’s at 70:1.
We can look at gold three different ways. It could be an inflation indicator. If this is the case, it has been a leading indicator. Back in December, after gold bottomed out at about $1050 and then rallied to $1380, it foretold commodity inflation. In which case, we should have bought a basket of commodities because the gold was a “canary in the coal mine.” Most other commodity markets rallied sharply. This was similar to the 1974 gold market, when gold hit $200 an ounce, and crude hit $50 a barrel, extraordinary prices for their time.
Gold could be a safe haven investment. In this case, this market would be a good buy if the state of the economy worsens dramatically or the general ”world situation” deteriorates. Uncertainty and fear lead to investment demand for gold.
The third possibility is that gold is just another commodity. Every commodity that recently had a nice bear market rally, has come down since. Specifically, in recent months: natural gas went from 160 in March to 300 in July, but has since fallen back into the 250s; wheat went from 535 in June to 400 earlier this month; soybeans went from 865 in March to 1192 in June, and then traded down to 969 cents a bushel earlier this month. If gold is just “the flavor of the month,” watch out below.
$1380 is proving to be a significant resistance level for gold futures. The $1380 level presents a 38.2% Fibonacci retracement from the highs made in 2011 to the lows of last year. Coincidentally, the $1380 level also corresponds with a trend line from the same highs of 2011. Gold has recently failed at $1380 several times.
Is gold an investment for our times? Let’s compare it to its’ main competitors.
Bonds compete with gold as “safe haven” investments; investors and analysts have always criticized investing in gold, as gold has no yield. Well, negative yielding bonds are worse than a no-yield investment. They cost investors money. The US dollar? Many have called it the safe haven of choice for those fearful of unstable worldwide economies. However, if you look at its recent performance, it has been anything but. Let’s look at the New Zealand dollar. Despite last Thursday’s OCR cut by the RBNZ to 2 percent, its lowest on record, it is still the best in the developed world and with its relatively stable economy, is able to attract foreign investment that the US dollar can’t. Do you like equities? The S&P 500 is offering investors a paltry dividend yield of 2%. A purchase of common stocks at this point would be purely speculative (though possibly highly profitable).
So what’s a trader to do?
If you think interest rates will continue to go lower, if you think inflation will pick up, if you think the “world condition” will deteriorate, or if you use “asset allocation,” gold could play an important part of your portfolio, and you would probably want to buy. If you think we will continue to have stagnating economies, with unimpressive inflation, an uptick in interest rates, and a quiet world situation, you might want to use these relatively higher prices to establish a short position.
As always, keep your account well-funded so you can be protected from short-term market fluctuations.