Is it a wrap for the gold rally?

on Mar 29, 2016

Since the beginning of the year gold has experienced a consistent upward trajectory; making it the best performing commodity of 2016, having gained 19% in value since the year began. Analysts at Global Intergold attributed the sustained growth in gold price to the fear that gripped the financial markets at the beginning of the year; making investors run to gold as safe haven. The fear in the market was as a result of the slow-down in China and the shocks it sent into the market as it transitions into a new economic strategy. Everyone eyed the gold and it kept reaching new highs each day. However, the sweet ride might be tipping off and the gold might be starting to cool off.

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Last month in February 2016 Janet Yellen delayed the rate that was expected to come in March following a similar rate hike in December. In her submissions, she said that she was monitoring the global economic trends with a specific focus on China, as well as monitoring the local economic indicators in the US before deciding on whether to raise the rates or not. Statistics from the labor market were among her list of items to watch as well as the inflation rates.

From the data released by the US labor department last Friday, it is clear that more jobs were created in February than in January 2016; with the figures standing at 242,000 and 151,000 respectively. Even with the increase in the number of jobs created, wage rates remained unchanged over the same period. The inflation rate remained at the eight-year low of 4.9% as per January. The growth in job numbers has however been interpreted to mean that the US is no longer being dragged down by the Chinese slow-down; and potentially evading the looming global recession. With this kind optimism starting to circulate in the financial markets, we will see more investors turning back to their normal financial instruments in the financial markets. This is because in the long-run gold is a store of value which cannot deliver as high returns as investing the stock and currency markets.

From the European Union (EU), the president for the European Central Bank (ECB) Mario Draghi announced yesterday that they were expanding the stimulus package that they began one year ago. He quoted the slow-down in China too as one of the reasons they had to protect the Eurozone through further quantitative easing; in addition to weak demand in the market which is threatening to drive the region into deflation. Under the new expanded stimulus package, the ECB lowered its benchmark rate to zero while reducing the rate on the cash parked overnight by banks by 10 basis points to -0.4%. As expected, the news sent the dollar appreciating against the euro immediately thereafter. In addition, stocks in Europe started gaining as investors started shifting their money from bonds to equities.

Normally, gold and the dollar have an inverse relationship; with gold losing its value as the dollar gains and vice versa.  With the dollar poised to appreciate against the euro, we can expect that gold prices will start plateauing in the short term; if the principle of their inverse relationship is to remain true. On the other hand we have the interest rate in the US expected to go up as the labor sector improves. This again is not good news for gold since it normally loses value when interest rates rise as most investors prefer to free up their cash at such times to take advantage of the potentially higher returns from the bond markets as compared to the stability on price offered by gold.

It is however important to note that interest rates are falling in Europe with some countries already in negative interest rate territory, which may encourage investors to opt for gold. Whichever of the two regions that has the bigger pull for investors will therefore end up determining whether the gold prices will go up or slip down.

Another factor to consider when looking at how the price of gold may move in the near term is the relationship it has with inflation. When inflation is rising, investors habitually prefer to preserve the value of their wealth in gold as currencies lose their value. On the other hand, as inflation falls, investors will sell off their gold and use their money to start acquiring other investment instruments. Currently, the euro zone is experiencing low inflation that threatens to dip into deflation; in the US inflation is at an eight-year low. Both scenarios seem to be encouraging investors to sell their gold and invest elsewhere.

However, with other factors that must be considered such as interest rates and the strength of the dollar, it becomes a little more complicated to make a straight forward prediction.



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