Last week I read an article in the Financial Times about the gold price. So far, gold has been one of the best investments this year. The gold price in euros is today exactly 20% higher than at the beginning of the year. But the gold price is still much lower than its record high of September 2011, when the gold price reached an intra-day high of $1,921.15 dollar per troy ounce. At $1,310/oz we are still far below that 2011-high. The true question at stake is therefore: why is the gold price so low?

The Simple Answer

The first answer to this question is simple: we are coming from very far. The gold price was that low, and gold as an investment was that hated, that even with an annual return of (year to date) 20% we do not even reach anywhere near the price that was achieved in 2011.

Let’s be honest. We are still almost 50% removed from the levels seen in 2011.

But that’s not the entire explanation of why gold prices are still that low. If we dive into the reasons behind the recent, quite amazing rally and the on the first sight undervalued gold price, we could arrive at the conclusion that in the short run there is still some room left for pessimism.

Readers that have been following me for some time know why I have been a bit negative about the performance of gold this year despite its recent strength and despite the fact that I am very convinced about the potential of gold in the medium run: and even I concluded last year that it was very likely that gold would average double digits returns for the next five years (something that unfolded this year exactly as predicted given the return on gold so far).

The Gold Price and the Interest Rate

Never in the history of the world were interest rates this low. At least this low in the Eurozone and Japan. And gold, a currency that has as it were a 0% yield, becomes more interesting and more demanded when interest rates tend to zero. What would you rather have? A bank account in euro’s which can be printed without any practical limits by the European Central Bank (ECB) headed by our beloved Italian Mario Draghi against a zero (or even negative!) interest rate or scarce physical gold against a zero interest rate? I have no doubts about which of the two options I would prefer.

On the other side of the ocean in the United States, the expectation is still that interest rates are on their way up. And the United States remains relatively more important, or at least important enough to undo the positive effect of zero interest rates in Europe and Japan on gold prices.

People tend to be sceptic about the ability of the Federal Reserve, the American central bank, to raise interest rates. Some even go as far as to predict that the Federal Reserve would never raise interest rates. Interest rate hikes would remain an eternal yet impossible wish; despite the Fed’s rhetoric an increase in interest rates would be out of the question.

These naïve skeptics have been silenced for now. Last December the Fed raised, after all, interest rates from 0 to 0.25% up to 0.25% to 0.5%.

And for now the expectations are that the Fed will continue hiking rates. Whether it will hike in September, November or December is largely irrelevant: the trend is clear.

Rate Hikes Will End Soon

Let it be clear for once and for all: the Federal Reserve is barely able to raise interest rates.

First the delinquency rate goes through the roof whenever the Fed raises interest rates a mere quarter percent. In other words, the Fed will sign its own death warrant. By hiking rates, it brings the U.S. economy on the verge of where it was in 2008: a deep recession. Whenever the Fed increases interest rates, many companies are not able to sustain themselves and the credit driven U.S. housing and car market will collapse.

Second the debt in the United States, especially at the public level, is that high that every rate hike is accompanied by much higher interest rate payments. Every rate hike means a tightening of the buckle. But there is moment when your belly gets in the way. In that case losing weight is the only remedy. With every rate hike, the Federal Reserve brings the U.S. nearer to a public debt crisis.

But for now the Fed has started a trajectory in which it promises to raise interest rates step by step. This expectation means bad news for the gold price. And this is one of the reasons why I think the gold price might go back below the $1,300/oz for now.

Only when it becomes clear to everyone that the Fed no longer is in the process of increasing interest rates, but of decreasing interest rates, will the gold price indeed reach the $2,000/oz and break its record high of 2011.

Until December Gold Prices under Pressure?

As long as expectations remain more or less the same, namely that the Fed is in the process of raising rates (and the market consequently anticipates various future rate hikes), the bull market in gold will not come off the ground.

Only when:

  1. The U.S. stock market crashes
  2. The U.S. economy goes into recession
  3. The Fed lowers interest rates for the first time instead of hiking rates

… will the trend change in the gold market.

This implies that we as gold investors might need a little bit of patience before the gold price begins its great rally: the rally that will bring us past the $2,000 per troy ounce barrier. Until that moment you can, however, still brag about your wonderful returns on your gold so far this year.


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