Gold Stocks Enter Correction Territory, but Investors Have Little to Fear
New York (Aug 6) Earlier this year, gold investors were on Cloud Nine. Despite having rallied to nearly $1,400 an ounce in 2016, the shiny yellow metal did something even more special – it kept above the $1,300 an ounce mark for its longest time period in five years. With Wall Street failing to increase margin expectations, it was my belief that most gold-mining stocks would handily surpass profit projections in the quarters that lie ahead.
But the tables have since turned. Since mid-April, gold has lost roughly $145 per ounce, or more than 10% of its value, placing it officially in correction territory for the first time in nearly two years.
A stack of gold ingots lying atop a hundred dollar bill.
Image source: Getty Images.
Explaining the recent correction in gold
Why the sudden swoon in gold prices? Chances are it's a mixture of worries.
For example, U.S. GDP for the second quarter recently came in at a robust 4.1%, which is the fastest quarterly growth rate since 2014. Generally speaking, gold benefits when there's economic uncertainty and fear. Strong growth tends to have a positive impact on the U.S. dollar, which, in turn, puts pressure on gold. The dollar and gold usually move opposite of each other. Plus, strong GDP growth is likely to coerce investors to buy riskier assets, such as stocks, rather than commodities.
Building on this point, a faster economic growth rate is likely to get the Federal Reserve thinking about its monetary-tightening cycle. This "tightening" involves raising interest rates in an effort to curb rising inflation. When interest rates rise, typically so do yields on interest-bearing assets. If these yields continue to rise, investors could choose to trade out of gold, which has no yield, in favor of these safer, interest-bearing assets.
Concerns about a trade war between the U.S. and China have also worried gold investors. Again, while fear and uncertain are typically good for gold, it's not such great news when a trade war could limit the import or export of products where gold is used, such as in certain types of electronics.
Add these factors together, and we get a pretty good glimpse of why gold prices have lost their luster since mid-April.
The word inflation spelled out by dice, in front of a calculator and multiple rising charts in a newspaper.
Image source: Getty Images.
There are plenty of factors are still working in gold's favor
Of course, there are also plenty of reasons for gold investors not to worry about the precious metal's recent drop.
Though this is a bit of a knee-jerk effect, we've seen inflation picking up in recent months. According to data from the Bureau of Labor Statistics through June 2018, the Consumer Price Index for All Urban Consumers has risen almost a full percent since the year began to 2.9% on an unadjusted 12-month basis. Higher inflation can curb gold's appeal in the face of Fed rate increases, but it also has the opposite effect by being a positive for gold.
There's also gold's supply and-demand outlook. According to newly released data from the World Gold Council, demand for the yellow metal fell 4% in the second quarter. While that's not optimal, most of that decline was based on exchange-traded-fund demand. Meanwhile, jewelry, technology, bar and coin, and central bank demand remained fairly consistent. That bodes well for the long term, especially with the market not facing any oversupply issues.
Gold should also benefit from unknowns and uncertainties that seemingly arise all the time in the stock market. Remember, since 1950, the broad-based S&P 500 has undergone 36 corrections whereby the index has lost at least 10% of its value. That's about one correction every two years, and plenty of opportunity for investors to seek the safety and store of value that gold is perceived to provide.
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