A Long Gold Rally Ahead?

Written by: Will Granderson

There were years in the last decade when it was tough to be a gold advocate. From late in 2011 until recently, prices were on a downtrend. As humans, the natural hard wiring in our brains is fairly simple when it comes to evaluating investments. If we can sell something for more than we paid for it, we most often think we made money. A good example is when we sell our home. Few of us take into account commissions (six to seven percent right off the top), inflation and maintenance costs when calculating the return on a home sale. Unfortunately, this goes a long way to explaining why most of us aren’t wealthy. It’s also relevant when considering gold prices recently, and into the future.

Some people bought gold in 2011 and 2012, then saw the price go down and assumed they lost money. What they overlooked is why gold prices were moving lower—and it wasn’t just gold; commodity prices in general were on a downward trend. Remember the crisis in the oil and gas industry just a few short months ago? Both the decline in oil prices and the decline in gold prices had a common source—the super-strength of the U.S. dollar.

Dollar Muscled All Out of Shape

The biggest reason gold prices were in decline was our powerful dollar. While many were critical of the Fed’s policy at the time in not following the lead of Europe and Asia into more currency-diluting quantitative easing, the U.S. central bank was being far more responsible than central banks in Europe, Japan and China that did deliberately devalue their currency. Global investors sought refuge in U.S. currency, bidding up the cost of dollars and lowering bond yields to the insanely low levels we see today. Since most commodity trades are denominated in dollars, as our currency got stronger that meant it took fewer dollars to buy the same amount of a particular commodity. To our primitive financial brains it looked (and felt) like we were losing money, but what was really happening was that our cash was worth more. Other factors accelerated gold’s price decline, including a hot stock market, but mainly it was the dollar.

Sanity Returns (Or at Least a Different Insanity Reigns)

The dollar was seriously overvalued also due to the U.S. Federal Reserve talking about interest rate hikes at a time when the rest of the world was printing currency and flooding their local economies with cash. But then the Fed got cold feet, put the rate hike on hold, and slowly the dollar started to return to its natural set point. That lit the fire under gold prices, which started an upward recovery. That ascent was given another kick in the pants by the Brexit vote, meanwhile, underneath it all, the dollar was quietly returning to more sane valuations.

Bonds Get Slaughtered

One of the traditional safe havens for investors moving to cash is bonds. Bonds come in many shapes and sizes, including government bonds, municipal bonds, corporate bonds and so-called junk bonds. Investors poured so much cash into bonds that the bond market is now a place where no sane investor puts money.

Out of the Confusion…Good News for Gold

Hopefully, that background makes it easier to understand where gold prices are going in the future. It took us years to get to where the dollar is today and there are years left in that arc. Investors are flooded with cash right now, partly because there’s nowhere safe to invest it.

If you leave your cash sitting in the bank, it will lose value (hence buying power) due to inflation.  It’s also subject to currency devaluation by central banks. Simply put, if your nation’s central bank devalues your currency, every dollar you own loses buying power.  Since the shock of Brexit, Europeans rightly fear for the future of the euro and the British pound – and they’re not the only ones.  The fates of American investments are also tied to the international divorce being played out in Europe these days. Gold is one of the few reasonably-priced assets left that is widely available to hedge the value of our dollars, as well as our dollar-denominated assets—that is our stocks and bonds.

A long overdue correction for the dollar, fear and uncertainty surrounding Europe and, lest we forget, continued concern about the strength of the Chinese economy means that, for the indefinite future, gold prices have nowhere to go but up.

Gold

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