Gold Price Drops to Lowest Level in 4 Weeks While Dollar Strengthens

May 1 2018

The gold price broke earlier this year convincingly through the $1,300 per troy ounce barrier. In January, the gold price reached a level of $1,365/oz. The last time that gold prices reached this level was in March 2014. It has been four long years. Many thought that gold was on the onset of a renewed rally, that it would finally truly break through the point at which every single gold rally hesitated over the past years. Nonetheless, gold prices are gradually falling back to that cursed $1,300/oz level. What can we expect in the short run?

The “Magical” 3% Barrier of 10-Year US Treasuries

It became earth-shattering news, last week. For a short, very short time, the 10-year rate on US sovereign debt broke through its magical three-percent barrier. And as a result, all alarms went off. Various scenarios were dusted off, because now it was serious.

First, the stock market would possibly fall off a cliff. Another ten basis points would truly make a difference: discounting future cash flows of corporate businesses at higher rates would lead to a long-awaited stock market correction.

Second, the bubble in bonds would finally burst: this would lead to enormous losses for holders of such bonds.

Third, increasing rates mean bad news for gold. As we have shown many times, gold goes well with a low or negative real interest rate. The cheaper a future dollar (or euro), the better.

And last: breaking through the magical three-percent barrier could imply a further normalization of the economy. Long-term rates would reach historically reasonable levels (say take and give four percent) any time soon. The demand for long-term credit – the driver of economic growth – is apparently getting stronger. The three-percent barrier is the end-game, a climax, to a long-awaited economic recovery after the 2008-crisis ended.

But … Nothing Could Be Further from the Truth

Nevertheless, many were drawing conclusions a bit too soon, as we have also observed on multiple occasions in the past years. The 10-year rate declined back to below the three-percent level. It almost seemed as if the public already gathered to celebrate Brazil’s next World Championship title, before Brazil really reached the final and actually won the cup. And the scenarios were put back on the shelf again.

And according to my judgment, the above scenario is one out of many possible scenarios: a scenario that without a doubt will become reality at some point, but perhaps not in the sequence that many expect.

The past few weeks, the dollar strengthened again: after the euro-dollar rate rose to a level as high as 1.25 earlier this year, the dollar is recouping some of its losses and currently stands at 1.20. The reason behind the stronger dollar is the same as in the past years: while the Fed rose rates earlier this year, the ECB hesitated. The economic growth in the Eurozone seems to be slowing somewhat. In July, the ECB will again (publicly) indicate where monetary policy will be heading.

Another scenario is, according to my judgment, likelier: contrary to what many think, especially short-term rates and not so much long-term rates will rise. Better yet: long-term interest rates might even initially decline, when US Treasuries will turn out to be the world’s ultimate “safe haven asset” yet again. All this will go together with a severe correction of US (and European) stock markets. Gold will probably suffer until that point – or even during the correction or crisis – to only rally at a later point. Only at a later point will real long-term yields probably reach far beyond current levels.

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