- Gold is seen as a hedge against central bank actions, pushing it to seven-year highs.
- However, as markets take a significant downturn, another rush to cash could be driving gold’s drop as well.
- Declining inflation expectations are taking the wind out of the sails of that investment thesis.
With markets declining over a weekend of protests and rising Covid-19 cases in reopened states, one would expect a few assets to be holding up well. One of those assets should be gold.
But as with stocks in general and other commodities such as oil, gold is taking a hit today as well.
Over the past year, gold is up over 2%, even following a drop during March’s market meltdown. Prices have plateaued in the past month. | Source: Bloomberg
There are two key reasons for the drop.
A Slowing Gold Rally is Leading Traders to Cash
In the short-term, we may be seeing the start of another move to cash by traders. That includes retail traders, who have helped drive a speculative bubble in share prices, including in that of bankrupt companies.
Back in March and April, during the worst of the market mayhem, retail investors were massive buyers of gold.
How massive? Their buys cleared out inventories of gold dealers in the one-ounce and smaller categories.
But it also includes professional investors who may have added more gold in their portfolios. Their reasons would be as a hedge against fear and a hedge against central bank activity that could lead to unchecked inflation.
Gold prices peaked in April at $1,789 per ounce, and have generally traded in the $1,700 range since, with one brief dip under $1,700 at the start of June.
That kind of slowdown indicates a failed rally. Gold has been unable to vault over $1,800 per ounce, even with the incredible amounts of money being provided to the market by the Federal Reserve.
Traders who are looking for a big move may be cashing out of gold to look for more attractive trades with higher short-term returns.
Signs Point to Lower Inflation Rates, Also Bad for the Metal
Many traders expect the Fed’s moves to create higher inflation and other problems. Historically, however, those issues have taken months to start to flare up, and the economy continues to look weak even now.
Looking out over the long haul, we can see this trend at play. Several countries are already lowering their inflation expectations.
We don’t know the full extent of the long-term damage from shutting down the economy quite yet.
But we know that it can have a powerful deflationary pull, much like in the 2009-2011 era. That’s not an environment conducive to higher returns from gold.
However, traders may believe it is and bid the metal up, much as they did back then.
Gold prices are still near seven-year highs. They would only need to rally another $200 to get back to the old highs over $1,900 per ounce set in 2011.
Gold made a parabolic move higher in 2011 as market fears soared, but the lack of inflation from zero percent interest rates led to a significant drop soon after. | Source: SDbullion.com
Those highs were formed on the back of a parabolic move higher that quickly fizzled out.
This time, when we get that kind of move, gold could trade far higher. An improving economy, fueled by zero percent interest rates, is precisely the kind of environment we had back in 2011.
So while gold is down today, it’s not out by a long shot. Perhaps this one-day drop is just a tempest in a teapot.
Disclaimer: This article represents the author’s opinion and should not be considered investment or trading advice from CCN.com.
This article was edited by Sam Bourgi for CCN.com.