High Anxiety Gives Gold A Boost

Key Takeaways

• Gold prices have hit a three-month high as investors see global equity and oil selloffs forcing the Federal Reserve to slow down interest rate hikes.
• If the Fed does delay, a selloff in the US dollar could give gold a lift.
• Motifs mentioned: Precious Metals

The rough start for most corners of the financial market has helped lift the profile of investments that often perform well when fear comes to the forefront.

Gold prices, for example, hit their highest level in nearly three months last Tuesday, as investors have begun betting that the turmoil would force the Federal Reserve to tighten monetary policy at a slower-than-expected pace this year as it tries to avoid further rocking already-turbulent markets.

Gold for February delivery, the most actively traded contract, closed at $1,120.20 a troy ounce on the Comex division of the New York Mercantile Exchange last Tuesday, its highest settlement since Nov. 2, The Wall Street Journal reported.

Other gold-related investments also have performed well. The Precious Metals motif, which has a nearly 85% weighting in the stocks of gold producers, has risen 7.4% in the past month. In that same time frame, the S&P 500 has fallen 5.1%.

Over the past 12 months, the motif has lost 32.7%; the S&P 500 is down 2.7%.

According to the Journal, investors increasingly believe that weeks of sharp declines in oil and equity prices have made it more likely that the Fed will raise short-term interest rates less frequently in 2016. Lower rates for longer would be good news for gold, which pays its holders nothing and struggles to compete with yield-bearing investments when borrowing costs rise.

“Gold declines last year were largely predicated on more robust Fed tightening,” analysts at HSBC said in a recent note cited by the Journal. “If interest rates do not rise as fast as previously anticipated, gold prices may adjust higher.”

Fed-funds futures, used by investors and traders to place bets on central-bank policy, showed last week that they see a 30% likelihood of a rate increase from the Fed at its March policy meeting, according to data from CME Group cited by the Journal.

The broad selloff in equities – and the parallel jump in gold prices – comes as a vindication for some market forecasters that have seen stocks as overvalued during the past several years.

One of those forecasters is MacroMavens President Stephanie Pomboy, who since 2010 has been bearish on stocks since 2010, arguing that the market was way ahead of the fundamentals amid the backdrop of an economy crippled by weak consumer spending.

(As a recent Barron’s Q&A with Pomboy pointed out, she also began warning clients in 2002 about a bubble forming in the US housing market.)

As Pomboy explained to Barron’s, her bearish view on stocks became even more extreme when profit growth started to crumble at the same time the Fed began tapering its quantitative easing in 2014. “With the era of the [Federal Reserve keeping rates at zero and buying bonds] now over, there’s absolutely no support left for stocks.”

Pomboy also is very bullish on gold, specifically due to the theory of what’s bad for the US dollar is good for gold. She maintains that the dollar “is wildly overowned.”

“I think there is zero chance that the Fed continues to raise rates this year and as those expectations come out of the market,” Pomboy told Barrons.com, “that will work to the detriment of the dollar and to the benefit of gold.”

Aside from gold’s attractiveness as a safe haven or inverse-currency play, more fundamental issues also could work in gold’s favor.

According to John Hathaway, manager of the Tocqueville Gold fund, financial constraints, investor bearishness, and the ever-lengthening time cycle to build new mines will lead to a moderate to severe decline in global gold-mining output before the end of the decade.

Discovery of new ore bodies has declined significantly since 2006, according to Hathaway, and without discovery, “there can be no new mines.” Exploration spending, down about 60% from the peak, has been among the prominent casualties of the industry’s hard times, Hathaway wrote in a piece for Barron’s.

What will eventually be an “acute shortage” of physical gold because of the mining industry’s incapacity is “extremely bullish” for future gold prices, according to Hathaway.

Gold investors could be vulnerable, of course, if better global economic data begins to surface – or if investors’ appetite for risk returns.

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