Global uncertainty, Fed rate hike drive gold market
London (Aug 20) Gold prices have been on a roller coaster ride. After setting a 2017 high on June 6 at $1,297.50/oz., gold subsequently plunged more than 7 percent within a month. On July 7, gold mounted a comeback, triggering a 9-week rally that pushed prices back up near its June high. Gold is a global commodity, and its price is subject to forces of global supply and demand. But a number of key factors have spurred this volatility and the recent demand that has driven investors back into the comfort of the yellow metal.
Gold is often viewed as a safe haven for global uncertainty and market turbulence. Investors buy gold and other precious metals because they see it as a constant, a tangible asset that will always have worth. Investments in currencies, stocks and bonds have no intrinsic value and derive their value by fiat – a declaration of value based on the faith and confidence in the issuer. Economies, financial systems and even entire countries have collapsed, but for centuries gold has proven its purpose in storing wealth.
On the global front, mounting tensions with North Korea over its nuclear missile ambitions, fueled by rhetoric from both President Trump and the rogue nation’s leader Kim Jong-un, have sent investors seeking shelter in gold, driving its price higher. North Korea’s ultimate goal is to have a nuclear tipped intercontinental ballistic missile, or ICBM, in its arsenal. On July 4, North Korea launched its first successful ICBM. However, its second launch on July 28 was the tipping point, as it proved North Korea’s missiles could now reach the U.S. mainland. Though North Korea still lacks the ability to arm them with a nuclear tip, its progression to that end has certainly raised alarms.
Domestically, the main driver of gold’s recent volatility has been the uncertainty of the Federal Reserve’s proposed interest rate hike, presumably in December. Gold prices are extremely sensitive to changes in interest rates, and as interest rates rise, gold tends to decline. You see, apart from price appreciation determined in the open market, gold bears no dividend or interest payments. It must compete with interest-bearing investments, such as bonds, for investor funds. As interest rates rise, investors typically shed non-yielding assets such as gold in search of higher yields in other types of investments.
But in recent months, the odds of an interest rate hike have been declining. Rate hikes require a U.S. economy and American consumer that can withstand their impact, as they constrict consumer spending and economic growth. The economy is plodding along at a moderate pace, yet still below expectations. Also, inflation projections have been recently lowered, reflecting an American consumer that is still not fully committed to spending their money. With consumer spending accounting for more than two-thirds of all U.S. economic activity, it’s a gamble the Fed can ill afford to lose.
Later this year, the Fed will begin unwinding its massive $4.5 trillion asset balance sheet. The assets, consisting of government bonds and securities, were purchased to help spur economic growth during the recession of 2007-2009. As it rolls these assets off its balance sheet, it will inherently drive up long-term borrowing costs, adding further pressure on American consumers and businesses.
With growing concerns on the stability of the U.S. economy and the impact from the Fed’s unwinding process, the prospects of a December rate hike are in serious doubt. In fact, the implied odds of a hike are currently just 46 percent, less than the flip of a coin. Without a rate hike, yields on many interest-bearing investments will not be driven higher, which makes gold more competitive and stokes its demand.
Finally, gold has benefited by the declining strength of the U.S. dollar. Year-to-date, the dollar has declined by more than 8 percent. Gold, like many global commodities, is denominated in U.S. dollars. A weaker dollar increases the value of a foreign buyer’s home currency, making gold cheaper to buy. This raises the demand, and price, of gold.
With an ever-changing geopolitical climate, lingering questions on the U.S. economy and continued political turmoil in Washington D.C., the recent volatility in the gold markets is certainly understandable. The potential rate hike in December only adds to the uncertainty. The financial markets will have a lot to digest in the upcoming weeks and months as they assess the second half of the year. But for now, they are looking to gold to help temper their concerns.
QuadCityTimes
