Has Gold Lost its Shine Forever?
Gold has always been a safe bet for investment and a hedge
against inflation. But this common belief turned into a nightmare
when the prices of gold crashed by almost 13% in mid-April.
Historically speaking, prices of gold have always moved inversely
to the major benchmarks, but since 2013, investors' confidence
tilted towards equities as seen in the graph below. The Federal
Reserve's monetary stimulus, the U.S. economy, major indices,
inflation and the gold prices are all part of one vicious circle.
If any one of the factors is adversely affected, a domino effect
will be generated affecting all the other factors.
In the last one year, the negative correlation between the
Dow Jones Industrial Average
) and the
SPDR Gold Shares
) has been around 46% and almost 82% since the start of 2013. In
the graph given below we see that in the past one year, till
2012-end, the Dow and the Gold ETF has been rallying almost hand
in hand but since the start of 2013, they take different and
opposite paths. Share price of
iShares Gold Trust ETF
) have fallen almost 17%. While shares of
ProShares Ultra Gold
) lost 31%, shares of
Sprott Physical Gold Trust
) have decreased 18.5%. Even if we consider the price of gold
before the huge sell-off which took place in mid-April, the
negative correlation is consistent.
What happened is not a bigger question than what is going to
happen in the long run. Investor optimism has played a major role
in the market rally since the start of 2013. The Federal Reserve,
which purchases $85-billion worth of bonds ultimately showed
results during the first quarter in the form of encouraging
economic numbers. Since 2013, major indices have gained more than
16% while the price of gold has fallen by 15%. These factors
cumulatively encrypted confidence towards equities rather than
The only reason why markets are doing so well is that investor
optimism is high and economic indicators are encouraging is
because of the monetary stimulus by the Federal Reserve. The Fed
indicated in April that if the labor markets continue to improve,
the monetary stimulus might be slowed. The Feds cannot continue
the stimulus on forever. What will happen after the Feds remove
the stimulus? Curbing the monetary stimulus will affect the
markets and price of gold indirectly.
Fundamentally, curbing the monetary stimulus, irrespective of
it being reduced in parts or as a whole, will adversely affect
the economy. Not only will the removal of monetary stimulus
affect the markets, but the sequestration cuts will also change
the corporate scenario. The second quarter, unlike the first
quarter, has witnessed a bump on the road. The effect of
sequestration cuts is likely be vivid from the second quarter.
The corporate results will probably take a beating. Hence, in
order to increase the profitability, companies might take cost
cutting steps, which in turn will affect the employment rate in a
small way. Profitably of the company might go below expectations.
The whole scenario of corporate earnings and economic data will
change the markets.
Adding to the investors' woes, the sequestration cuts along
with slowing or shutting down the Fed's monetary stimulus will
rattle investor confidence, thus increasing skepticism towards
the markets. Whenever fear towards markets has risen, investors
have mostly turned towards gold to park their investments. But,
by the time the Feds lift the monetary stimulus, if the inflation
rate is not around 2%, it can create an adverse effect.
Inflation, unlike the markets, is not controlled by the
investors' sentiments. Materially speaking cost of products has
gone up but the global inflation rate has gone down, triggering
the fall of gold prices. Apart from controlling the unemployment
rate, bringing the inflation rate to 2% was also a reason for the
Fed to introduce the monetary stimulus. As of now, inflation is
just half way and hovering around 1%. At this stage if the Fed's
slows the monetary stimulus, it can possibly create panic in the
short run. Low inflation rates will keep pressure on the gold
prices, at the same time investors will lose confidence in the
markets, triggering panic in the market.
In a scenario where the inflation rate is 2% and the Feds slow
down the monetary stimulus, owing to sequestration and lack of
monetary stimulus support, the markets will still be affected,
but in this case, the prices of gold will tend to move higher.
Investors will start accumulating funds in gold due to lack of
confidence in markets.
The next possible trigger which will probably impact the
market is the outcome of the Fed's meeting due in mid-June. The
outcome will likely decide the direction of markets and gold
SPDR-GOLD TRUST (GLD): ETF Research Reports
ISHARS-GOLD TR (IAU): ETF Research Reports
SPROTT PHYS GLD (PHYS): ETF Research Reports
PRO-ULT GOLD (UGL): ETF Research Reports
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