Gold Is Up 15% Since January 1 — What Is Driving Prices? 23 Feb 2016

Gold Is Up 15% Since January 1 — What Is Driving Prices?

Until 2016, gold and other precious metals had been in a steady decline for approximately four years. In a sudden turnaround, gold prices have recently increased by 15 percent in just six weeks to levels approaching $1,260 per ounce. During this same period, the Dow Jones Industrial Average is down about 8 percent.

Among the reasons for improving gold prices are:

  • Reduced global economic growth
  • Increasing emerging markets demand
  • Lessened expectations for U.S. interest rate hikes
  • Decreasing mine output

Each of these four reasons is discussed in more detail below by Research Optimus.

Worsening Global Growth Prospects Make Investors Nervous

There are two significant indicators that the worldwide economy has been slowing down. First, the slowdown of the Chinese economy has been accompanied by a dramatic sell-off in the Chinese equities markets and to a somewhat lesser extent in other international stock markets. Second, energy and oil prices have continued a steep downward trend that is also reflected in declining stock prices. Additionally, oil prices are generally used as a proxy for industrial activity — and increasing oil inventories combined with reduced energy usage by manufacturers are significant signs pointing to an economic slowdown.

Rising government debt levels also explain current investment uncertainties. The possibility of “Too Much Debt” can make both long-term inflation and increasing government austerity more likely. Excessive corporate debt is an equally significant factor — and recent declines in high-yield corporate bond prices are also symptomatic of debt concerns that can impede economic growth.

For investors interested in safe-haven buying opportunities that will protect their capital, gold and other precious metals such as silver offer a prime investment alternative — particularly in light of the four-year decline that had taken gold to about $1,000 per ounce during the fourth quarter of 2015. “Buying low and selling high” is often the prevailing wisdom in prudent investment strategies. Buying low-priced gold can feel “safer” than buying high-priced equities — hence the “safe haven” reason for recent gold price increases.

For now, the safe haven factor is seen primarily from western and institutional buyers. The safe haven sentiment is reflected in a recent statement from Bron Suchecki of the Perth Mint in Australia — “We had a client call up this morning and order a million dollars of gold.”

The Demand from Emerging Markets Is Just Beginning to Show Momentum

It is somewhat ironic that one of the primary explanations for increasing gold prices is the “potential impact of buyers in emerging markets” rather than their actual buying behavior so far. When this article was published by Research Optimus, it was western gold investors who were predominantly pushing prices upward.

Nevertheless, the potential for eastern investors to drive gold prices higher is evident in several specific markets such as China and Russia. The Chinese Yuan and Russian Ruble currency weakness has already been a major factor in gold price appreciation — and this trend appears likely for the months (and possibly years) ahead. Russia’s GDP fell 3.5 percent in 2015 and 2016 forecasts are not bright, in large part due to the impact of low oil prices. With the Russian currency at depreciated levels, gold prices in Russia are currently at record levels when measured in rubles. As one immediate result, Russia’s central bank is motivated to back up its currency by buying more gold.

When inflated asset bubbles appear anywhere, investors often seek “hard assets” such as gold. With low interest rates coupled with declining equities markets, impacted investors in emerging markets will have additional reasons to consider buying gold.

Postponed Interest Rate Hikes in the United States

During the latter part of 2015, the U.S. Federal Reserve Bank announced its intention to gradually increase interest rates in 2016 and beyond as part of a strategy to control inflation. The original Fed plan was to raise rates four times during 2016, but the rough start in global equities markets at the beginning of the new year has dampened the enthusiasm for pursuing this strategy. Fed Chair Janet Yellen told Congress that March rate hikes were not guaranteed, and she revealed a strong belief that negative events in foreign markets must be considered — “Foreign economic developments, in particular, pose risks to U.S. economic growth.”

With worsening economic conditions coupled with low inflation rates, the rationale for rate hikes by the Federal Reserve is no longer viewed as a sound strategy by many economists and banking experts. For example, as Brett Ryan of Deutsche Bank observed, “Forget about March, forget about June.” To make matters somewhat worse, many U.S. banks have already imposed tighter lending standards — higher interest rates would be likely to reduce lending activity even further.

Interest rate increases often cause other investments to become more attractive relative to gold. When the Fed announced plans for rate hikes, this temporarily dampened the appeal of gold — but the likely postponement of interest rate increases restores some of gold’s financial luster.

Producing Less Gold Means Less Supply and Higher Prices

In a powerful illustration of the Law of Supply and Demand, decreasing gold mine outputs lead to reduced supplies that typically translate to higher prices. For an extended four-year period, gold miners have experienced lower prices for their primary product — gold, silver and other metals. Numerous mining companies have reduced current mining and stopped more expensive mining exploration activities because prevailing gold prices meant that it was difficult to make a profit by selling gold at current prices.

Much as the energy industry has reduced drilling and laid off thousands of employees due to low energy prices, the mining industry scaled back many operations to save costs and avoid selling gold at prices below production costs. The decline in gold mining output during the fourth quarter of 2015 was the largest in an eight-year period.

With increased demand by investors for gold during a period of shrinking production, a sharp increase in the price of gold is to be expected. How long this reduced production will continue is not yet clear — it can take many months (even years) for some mines to return to previous levels of activity since mining companies will still be short of sufficient working capital in all too many cases. Higher-cost exploration for new mines and gold reserves is also not likely to resume until gold prices are sustained at higher levels for an extended period.

Conclusion: Investors Need to Stay Up-to-Date with Due Diligence Help

Gold prices have improved recently, but investors should always expect price fluctuations in commodities markets. Decisions about buying assets like gold should not be rushed into until investors have performed a sufficient amount of due diligence to support a long-term investment.

While some experts foresee a gradual recovery in gold prices during 2016 and beyond, such predictions are typically made in a fluid environment that can rapidly change. A prudent strategy is to obtain the latest updates and forecasts from independent experts such as Research Optimus. This will enhance your opportunity to minimize investment risks while optimizing investment returns.

– Research Optimus

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