Investors in gold equities have watched their positions fluctuate between lower highs and lower lows for almost three years – and the golden sunset they were anticipating appears to have turned into a seemingly endless dawn.
Not much has fazed the downward action in gold including the Russian-sponsored war in eastern Ukraine, the prospects of Greece leaving the Euro and the toppy US market which always seems to find a reason to go higher. Short of some major military confrontation among major powers (heaven forbid), you have to wonder what sort of geopolitical event would actually move gold significantly higher.
To add some historical context, the Russian invasion of Afghanistan in late 1979 was a key driver of the gold price, pushing it above $500 per ounce by year end, more than a 100% gain for the year. In the next month, gold gained another 60% before beginning its precipitous downward trend on the heels of US Federal Reserve Chairman Paul Volcker’s high interest rate policy which killed inflation and the global economy with it. If you think commodity prices are bad now, have a look at statistics for industrial metals during the early 80s. Quite simply, they were depression era prices.
Among the primary downward forces affecting gold today is the strength of the US dollar which has been on a tear since the summer of 2014. Some of that strength is based on the expectation that the Federal Reserve will raise interest rates later this year, something Nobel laureate and economist, Robert Shiller, predicts will have no initial impact on the US economy whatsoever.
As far as the US dollar is concerned, a modest interest rate rise of 0.25% is probably factored into the dollar already and, by default, into the gold price. Most analysts agree that rising interest rates at some point will tank the market whose primary driver has been low interest rate generated liquidity.
Gold generally trades inversely to US dollar strength although in recent months it has sometimes followed the dollar higher. However, that perfunctory relationship – although potentially significant in the longer term – appears to have been a temporary aberration.
Like other commodities, gold is denominated in US dollars, the price markets and investors tend to focus on. While lamenting US dollar prices for gold, investors often fail to realize that gold can rise in other currencies that are depreciating relative to the US dollar. Some good examples are the Euro, Canadian dollar, Australian dollar and Japanese yen.
As a matter of interest, Canadian gold producers aren’t doing all that bad in their own currency and lower oil prices are helping their bottom line because energy accounts for 25 to 30% of operating costs. You would think the market would recognize the upside for these stocks with gold prices apparently bottoming along with the currencies of the aforementioned countries. Talk about a potential double bang (both stock and currency appreciation) for your buck!
As we can see in the chart for the HUI “goldbugs” index, gold stocks have also traded inversely to the strength of the DOW which is probably understandable because bullish sentiment in one index tends to be the product of bearish sentiment in others.
To buy or not to buy – now that is the question. From my experience any investment in gold is a three year commitment at least. The same applies to other industrial commodities including copper, nickel, zinc etc. which are highly cyclical. Where the real discipline comes in is in setting price targets for profit taking.
Gold and other commodities will recover at some point. And if the past is any measure of the future the senior golds will move first (after all, they have the best production leverage to gold prices), with the intermediate producers not far behind, followed by the juniors which are the riskiest and most volatile but typically produce the highest returns. Barring some Black Swan type event, a real recovery in the gold market could be a few years down the road. When it will turn is anyone’s guess – but it will happen. When the pendulum swings back, it could be a heck of a ride!