Gold Falls Below Price Floor

July 6 2018

To say that gold is getting dealt heavy blows would be quite an understatement. Over the past weeks, the world’s leading precious metal saw approximately $100 dollars shaved off its price. Compared to a year earlier, gold prices are now roughly $50 dollar lower. And a comparison with its peak of about $1,900 dollar would lead to an even more dazzling conclusion.

Not Much Has Changed in the Geopolitical Situation

To be honest, the above price developments should not have surprised anyone. If we look at the past twelve months, we see for instance that the geopolitical situation in the world has not changed much. Admitted, it was not that long ago that the odds of a nuclear war between North Korea and the US were increasing, but for now peace has been restored, after a meeting between Donald Trump and Korean leader Kim Jung Un.

In terms of monetary policy, the world’s most important central banks such as the Federal Reserve and the European Central Bank (ECB) have entered a new era, that is, the era of monetary tightening. This tightening cycle is off to a somewhat timid start, especially in the Eurozone, where the ECB has cautiously begun to taper quantitative easing and to raise interest rates somewhere in the second half of 2019. But the times of increasingly loose monetary policy lie – for the moment – behind us.

Interest Rate Hikes

Especially in the US, the Fed has been eager to tighten monetary policy. Interest rates were raised on multiple occasions and the Fed is looking to hike rates another five times on the other side of the ocean before the end of 2019.

The outlook with regard to global economic growth this and next year are quite positive. Even though economic growth appears to end up somewhat lower than in 2017, the rate of growth continues to be relatively positive.

Interest rates in the US are also on the rise, albeit at a slow pace. The enormously important 10-year rate is flirting with a 3% resistance level. This implies that for the first time since a very long time, investors now have an alternative for precious metals that also provides a decent return.

Add to that something I call a ‘feeling of deception’. Even birds in the sky know that an ancient-old rule of thumb states that whenever monetary policy has been loose for a substantial period, that is, the printing presses have been running at full speed if you wish, precious metals profit from loose monetary policy since it normally does not take very long before inflation comes around the corner. Another rule of thumb says that the looser and the longer loose monetary policy persists, the greater the odds of high inflation.

The only problem with these rules of thumb, is that they do not seem to apply to modern times. After central banks such as the Fed and the ECB have kept rates or continue to keep rates at zero percent and have purchased trillions of government and corporate bonds, inflation has not been much higher than between 1.5 and 2 percent. Those are not the inflation rates that would frighten the average household or investor.

Decline in Gold Prices Was Expected

With all those developments in the back of our minds, the decline in the gold price should not really surprise. But …

We could raise some question marks with regard to the above. Moreover, in order to understand the background of the earlier-mentioned rules of thumb, we must understand the inner workings of the monetary mechanism. Only then we can answer the question “has the situation changed; did past laws cease to apply?”. To be continued.

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