Back in 2011, the price of gold peaked over $1900 an ounce, an all-time record. This was at the end of a big run up in gold prices. Is gold headed back to that area again?
Gold has certainly been on a nice run. In less than 3 months, its price has risen from $1275 an ounce to $1514, a gain of 19% over this short period of time. Gold is certainly running with the bulls, but just how much further might it go?
We’re still about $400 an ounce from gold’s all-time record, set in 2011, at the peak of what was an historic move in gold, gaining 155% in less than 3 years. Gold certainly has shown it can run a long way, and this current move might just be the start.
This might especially be worth watching if the Fed actually does keep moving interest rates down. While quite a few people believe that gold prices and the Fed overnight rate are negatively correlated, this hasn’t really been the case, at least when we go back to the length of time that people use for these correlations.
However, it does make sense that interest rate cuts would benefit gold, as these cuts weaken the dollar and a weaker dollar is generally bullish for gold. Interest rate cuts also tend to come at a time where the stock market and the economy is weaker, and these cuts generally serve to address these deficiencies, although we could argue that this latest one was more for show than anything.
Show is plenty enough of a reason for people to do things like buy gold, and when you see bond yields go down in tandem, this also serves to make gold more attractive to the yield seekers at least.
Since the Fed cut rates at the end of July, gold has risen a full $100 an ounce, and people’s concerns about bond yields along the way added some extra help.
We all know what happened in 2008 where the Fed cut rates 7 times an knocked off a full 4% off the overnight rate. By the time the final cuts were in, this is when gold took off on its journey upward, and even though there were no more cuts because the rate was cut down to zero, it spent the next 3 years breaking all its records for bullishness.
The stock market also rose during this time, and it’s not the case that gold prices and stock prices are all that inversely correlated, as this really depends on the situation. As we moved further and further away from the great fall of 2008, both assets benefited from the improved optimism.
Gold didn’t actually have a very good year at all in 2008, and spent most of this year going the wrong direction. Sure, it didn’t take anywhere near the beating that stocks did, or anything close, and therefore did serve as a hedge of sorts, the best hedge back then with stocks was cash, as bonds didn’t fare that well that year either.
The effect of all those cuts did wear off though, and we eventually saw rates climb back up, something that isn’t generally particularly good for gold. To the extent that we do have this correlation, it is at least comforting to know that we should not expect any rate hikes anytime soon, whether or not the rate goes lower.
We Can’t Just Be Guessing Here
When it comes to managing investments, the less we depend on guesses the better, and some people got a real lesson here recently, the ones that actually took the advice of some analysts and shorted gold in the days leading up to the latest Fed meeting. Gold was showing some signs of tiring at that point, but not very much and certainly nothing that you’d want to exit over, let alone short.
While we might want to come up with some ideas about things like gold, it is very important to seek confirmation from the market that we may be right before we leap. Shorting gold into an FOMC meeting that we knew would involve a rate cut is simply reckless, and whenever we seek to pick a top to short or a bottom to buy, we need to be very careful, lest this involve the old adage of trying to catch a falling knife. These knives can really cut and especially golden ones due to gold’s volatility.
We need to use the same approach when we come up with ideas such as there is an undercurrent of demand for gold, as Brien Lunden, editor of Gold Magazine, has been putting forward lately. This is an interesting idea, but is one that needs to make it to reality to put too much stock in it.
It is not that we shouldn’t necessarily buy gold based upon such an idea, but if we do, we need to make sure that we are going with the current trend and also be ready to jump off if the ride becomes too rocky or things simply start falling apart at some point.
The biggest lesson that investors of all skill and experience levels need to make sure that they have learnt is that we get into an investment with a certain set of expectations, and when these expectations no longer become valid, this is no time to be foolish or stubborn.
If this underlying current has its way, we will know it, and when the current dissipates, we will know it as well. If we predict that something will keep going up and it doesn’t or it stops, we might have been right to this point, but we’re being told that we’re not now, and we have to listen.
Lundin doesn’t see the recent turmoil as being the decisive factor here, but is focused on longer-term “issues of monetary debasement and other geo-political factors.” There are always such things going on to some degree and we may wonder why today’s environment would stand out so much compared to the past.
Others may see this play as looking to take advantage of all the concerns out there about a potential recession visiting us, but if gold didn’t do that well during the Great Recession, it might not be that reasonable to expect that it will do so well in whatever little recession that people are afraid of today.
Gold Might Do Well Over the Near Term, but it Must Speak for Itself
One of the things that happen in recessions is that people have less money to invest and actually end up taking money off the table, and this can include spending their gold. If we were in a recession and gold was moving up like it is now, we would have a good argument to buy it, but we need the conditions of our assumptions to be present to even make them applicable.
If we do get a recession, which isn’t even that likely, then we can start talking about what is good to do during a recession. Right now, the economy is actually amazingly stable, so we need to ask what works in this environment, because it’s the one we’re in.
Stan Bharti, CEO of merchant bank Forbes and Manhattan, also believes that there is a lot of unexpressed longer-term bullishness with gold. He states that in the last “8-10 years we’ve seen a bull market in stocks and lived in a low interest rate environment. That is dangerous for inflation.”
The price of stocks has nothing to do with inflation, so it’s completely unclear why this was referenced, but low interest rates can cause inflation at times. They sure haven’t caused any yet over this period and aren’t causing any now. If and when they do, you can bet that they won’t be so low for very long as the hawks at the Fed will be out of their cage and all over this problem.
Inflation rates are low now in spite of low interest rates, and interest rates are carefully managed these days to ensure that this is kept close to objectives. While this may not have been the case at certain points in the past, our central bank has graduated from tinkers to economic engineers over the last few years, particularly after the lessons of 2008.
If we believe that inflation rising will put up the price of gold, we should at least want to wait to see this happen first, otherwise we’re going from a potential correlation to a mere guess. We also need to at least see this inflation to even have the conditions of our bet present. To make this even worse, if we know a single thing about our economic outlook, it is that inflation will remain low for a while at least.
Gold can be a good hedge against inflation at certain times, but we need the problem to appear before it makes sense to implement a solution. Hedging is a valuable tool but it needs to be used judiciously, which includes when it might make sense to use it. We also need real evidence to support this and not merely hypotheses that may or may not be valid or come to pass.
Gold may indeed make it to $2000 an ounce or higher, but a lot has to happen to get there. It does have a lot going for it right now, and when we finally see bonds cool off, and if gold is moving up at the time, we could see a meaningful flight toward it.
Beyond that, our wanting to stay in gold or to build our positions needs to be based upon what the market is telling us first and foremost, and while we are free to speculate on the future, we need to be fully planted in the present as well, and always make sure that our visions and reality are aligned.