Gold Prices in 2016: Where Are We Heading?

June 6 2016

After a miraculous first quarter, gold prices began to correct again. After the first five months, gold has returned 14.3% (or 10.9% in euros) year-to-date. The gold price broke through the $1,300/oz-barrier, but has declined over the past few weeks to just above $1.200 per troy ounce. The gold price in 2016 has exceeded expectations by a landslide, but what is the outlook for gold prices in the second half of 2016?

Rise in Gold Prices in February 2016 Not Very Convincing

Within no time, gold went from the most hated asset in the world to the most loved. After slumping for many months, it was only to be expected that gold prices would rally at a certain point. That rally came at the beginning of this year, 2016. Gold prices rose from the end of January until the beginning of February in a mere twenty days from $1,100/oz to $1.250/oz.

In just twenty days, you could have earned a return of 13.6%. With current savings rates (at least in the Netherlands, where the highest savings rate is currently 1%), it would take almost thirteen years to match this return. Little is left of the eighth wonder of the world, as Albert Einstein once labeled the law of compound interest, with the interest rate levels of today.

Not only gold prices recovered, but also other commodity prices. The silver price, for instance, went up even faster (the gold-silver ratio declined from 82 to 72). But also oil prices recovered some ground. And even more important: the euro also appeared to have a relief rally. The EUR/USD rose from $1.04 to $1.15 dollars.

And that is exactly the reason why the current upward trend is doomed to end prematurely.

Correction in Gold Price Not Yet Over, First Quarter of 2016 Was a Temporary Rally

Last September, I already argued that the correction in gold prices was not over yet. And what applied then, still applies (to a large extent) today.

The inflow to the dollar, after a brief pause, will continue unabated. Central banks that think they are capable of defending their currencies, will again lose foreign exchange reserves in droves.

There are two reasons that the dollar will continue to rise and (probably) reach parity with the euro:

  • A recession is coming and the dollar is and remains, as ultimate liquidator of debts, the first and foremost safe haven;
  • The interest rate differential (the difference in rates) on European and U.S. interbank markets is increasing, not decreasing. Carry trades (buy dollars with borrowed euro’s) will proliferate.

What does this mean?

This most likely implies that gold prices and silver prices in 2016 have some downside left. It also implies that U.S. equity markets will (probably) outperform other stock markets around the world, until the recession hits. Also, interest rates on U.S. Treasuries could remain low for the foreseeable future (or even decline further).

But as soon as the recession hits, U.S. equity markets could also drop more than its foreign equivalents, because it will have more downside. The knife cuts both ways. Tech stocks, as well as junk bonds, could be the biggest victims of the recession.

The trigger for a new recession will probably have its origin in China. A further stagnation of economic growth there (let’s call it for the sake of convenience a Chinese recession), will also have severe consequences for the extremely weak U.S. economy, especially in the midst of (upcoming) rate hikes by the Federal Reserve.

In its current state, the U.S. economy is utterly incapable of enduring the following two things:

  • Rate hikes; and
  • A sluggish Chinese economy.
Regarding the former, the Federal Reserve appears to push the U.S. economy down the abyss rather sooner than later.

Next Rate Hike in 2016 Will Put the Gold Price under Pressure

While many were completely ruling out any rate hike in June, Janet Yellen swiftly tried to straighten out this misunderstanding. She wanted everyone to know that, despite prior statements by the Fed, it was likely that the Federal Reserve in 2016 would raise rates at least once or twice.

Moreover, the Fed is trying to emphasize its independence. Some analysts were already arguing that the Fed would not be prepared to hike rates in the midst of fierce presidential campaigns (U.S. presidential elections will take place later this year). Janet Yellen wants to show once and for all that the Federal Reserve is not taking any cues from Washington.

One of the ways Janet Yellen might do that, is by raising rates during one of the fiercest presidential races in history, between Republican candidate Donald Trump and Democratic candidate Hillary Clinton. But tightening cheap central bank funding during an election cycle, is deemed politically inappropriate.

A rate hike perhaps in June, most likely in July, lies ahead. And despite the fact that not any economic law tells us that rate hikes without any exceptions negatively impact the gold price (do not forget that gold prices in the years preceding 2008 rose, even though interest rates were hiked little by little), I still expect a disappointing summer for precious metals.

It should surprise nobody if gold prices for the year 2016 end up in red, instead of ending convincingly higher, just like it was the case in the first quarter.

Forecast Gold Price 2016

After my predictions for the first quarter of 2016, with which I ranked third among analysts from ABN Amro, Citi, Deutsche Bank, Standard Chartered, Societe Generale, Morningstar and the World Bank, I have no problem with putting my reputation on the line by forecasting where gold prices are headed for the remainder of 2016.

But would it make any sense? Probably not. Investments do not care about any price targets. And especially in the case of gold.

Whatever the case, I would be surprised if the gold price would end above $1,200/oz in 2016. And I would not be surprised if gold prices would fall back all the way to $1,100/oz or, who knows, to $1,000/oz.

That, however, would not do any justice to gold as an investment. If someone would call me right now and ask me in what an average investor should invest, then my answer would be to buy gold for every month over the next six months, and buy dollars as soon as possible.

If at the end of 2016 your portfolio consists of both assets, then you will have probably a pleasant year ahead. And as soon as the recession starts to impact Western stock markets around the world, then you will have plenty of ammunition to spend on other investments than gold. Owning the dollar until then, means you will have enough ammo the moment great opportunities arise elsewhere.

Gold Not a Hedge against Uncertainty, But an Investment in Uncertainty

Almost everyone I talk to, says that gold is a “hedge” for them against monetary disaster. But gold is not a hedge, as writer Jim Grant emphasized this week rightly, but an investment in such disasters.

Some say that investing in gold protects them against an “Armageddon,” but Armageddon in financial markets is rare. Moreover, an Armageddon is in no way necessary for higher gold prices.

Gold is an investment that will profit from the great monetary illusion of today, which will end very badly for other, more traditional investment classes. And in that light, it is smart for every investor to hold a (relatively) large share in gold.

Investors that do not buy gold because they feel some gold investors are too extreme in their investment thesis, are shooting themselves in the foot. The world will not end, but that we are in the midst of a financial pipe dream is undeniable.

The (naïve) trust some have in a good ending of the biggest monetary experiment in the history of the world, is adorable. But eternal optimism might help entrepreneurs, politicians, school teachers and corporate consultants to succeed. Investors and speculators require, however, a healthy dose of realism. And in the end we all, except if your plan is to never to retire, are investors.

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