Growing Pains for the Dollar and Permanent Volatility Mean Party Time for Gold

Sometimes being a gold investor is lonely—and then there’s 2016.  Gold is up fourteen percent this year while the S&P 500 is off nearly six percent. The combination, for those who took our advice in 2015 and sold some high flying stocks to buy gold, means a nearly twenty percent spread.  That’s the kind of margin that gets the attention of even the most jaded stock market investor. Now there’s mounting evidence this could be only the beginning, with some industry insiders calling for $1,500 an ounce gold.

The factors that led up to the wide mismatch between gold and stock prices were easy to see coming. Stock prices were being driven higher by corporate boards borrowing money and buying back their own stock. That caused a share price increase, which garnered those executives some nice bonuses, but with no corresponding increase in company value. At the same time gold prices were being pushed artificially lower by a number of factors. A correction at some point was inevitable and, unlikely as it seems, events in the Chinese stock market proved to be the trigger.

As the global fallout from Chinese reverses is still being assessed we’re seeing some correction of the gold-stock imbalance, but not enough to right the scales. There are several reasons the correction, particularly in gold prices, is likely to continue. Market values were so stretched out of shape on so many fronts that the return to fair market value is going to be a long journey. There are several factors affecting gold prices in the days ahead that will be remain significant.

Volatility Everywhere

For the small investor, the key reason to buy gold is as a hedge against the purchasing power of your currency. Dollars lose purchasing power much faster than gold does. That’s why high quality gold bullion should be a part of every conservative asset mix.

But for some large investors the spur to buy gold, and lots of it, is as a hedge against global volatility. Since gold tends to be a lower-risk investment for the wealthy, when you see volatility you can guess the rich will be buying gold – thereby driving up the price.  As we’re entering a new age of global economic volatility that appears to be permanent, this will make gold an increasingly crucial component of portfolios going forward.

Commodity Prices Artificially Low

Gold and silver are both precious metals and commodities, thus subject to some of the same market forces as other commodities. While other countries are engaging in stimulus and printing money, the Federal Reserve, by contrast, chose to raise interest rates in December. That caused global investors to flock away from their own de-valuing currencies and towards the dollar, driving its value relative to other currencies into the stratosphere. So far the Fed’s professed intent to continue raising interest rates will keep a lid on commodity prices but that policy can’t last. The super-strong dollar is putting U.S. companies at a competitive disadvantage in the global market; a situation that can’t go on.  At some point the Fed will have to move to weaken the dollar, causing that drag on the price of gold to evaporate.

And Did We Mention the Dollar Must Come Down?

Chinese banks are burning through their foreign capital at an alarming rate as frightened citizens, finding their yuan losing more and more value, race to exchange them for stronger global currencies.   Meanwhile the European Central Bank is printing euros like there’s no tomorrow in an attempt to buttress the economies of certain member nations.

Have you spotted the trend yet, and who is bucking it?  Yes, the Federal Reserve is going to become ever more an outlier and will be forced to devalue the dollar. China won’t have a choice; the yuan is barely holding on to current values by a thread. Europe and Japan will keep dumping stimulus cash into their economies because it makes their goods and services more competitive with the United States. In other words, other world economies are magnifying their reach in global markets at our expense. Why the Fed has allowed it to go on so long is a mystery; that we can’t afford to do it much longer is a fact.

All of those factors combine to provide upward momentum for gold prices. Certainly there will be a lot of ups and downs in the daily trade price but the long-term trend seems well established.