It’s starting once again. Investors are wondering whether now is the best time to buy gold. For more than five years (since July 2013), gold’s price per ounce has been oscillating around $1200/oz within +/- $100. But, just look at the US Federal Reserve’s assets to affirm gold’s price decline and trajectory.
Fundamentally, gold’s price moves based on supply and demand, like any other market. Many speculators are involved in the precious metals market, and prices can swing wildly as panic or euphoria sweep through the broader capital markets. Over long periods of time, gold provides a real rate of return that’s barely above the rate of inflation. In shorter periods, returns can manifest randomly.
Just consider that in during the first eight months in 2011, gold’s price jumped 33.6%, while the S&P 500 had dropped 11.6% at that point. Gold typically does experience great short-term gains, especially when there’s general panic and worry regarding stock prices. This has everything to do with only one underlying fundamental of the gold market – increased investor and speculator demand – which is a behavioral challenge for most investors.
If you’re looking at broader trends, we find general gold price movements that also make sense. One such historical standard are times of expansionary monetary policy. This is when the Fed is creating lots of inexpensive new capital (US Dollars) for individuals and businesses to use to finance all kinds of consumption desires. When there are more US Dollars floating around the world, US Dollar supply is increased (this is done through some fancy FOMC activity). Assuming the same level of US Dollar demand, an increase in supply without a change in demand would result in a lower market price equilibrium point (remember that from Econ 101 at college?). The value of the US Dollar would lose relative value as compared to other currencies.
Conversely, a Fed monetary policy that is contractionary and more restrictive means that US Dollar supply is being reduced, and US Dollar value would be increased as a result. This is an oversimplified explanation. There are so many factors related to the goings on of other central bankers that could change the US Dollar’s relative value.
So far this year (as seen in the accompanying chart), the Fed has reduced its balance sheet assets more than 5%, through a combination of selling or simply not replacing bonds that have matured. This has the direct effect of creating higher interest rates for US Treasuries, which are solely denominated in US Dollars. Higher interest rates are attractive to investors, especially global investors in search of higher but safe rates of return. US Treasury bonds pay more than any other investment-grade national government issuer. Demand for these bonds will continue to be strong until such time that UK and/or Germany pay rates that are on par with the US.
Gold has lost its luster. As the Fed has marched back monetary supply, gold’s value has also correctly fallen. There’s less concern that the US Dollar is significantly over-valued, especially considering recent money supply reductions. There could always be a spike in gold prices, but it’s not easy to see how such a trend would continue, as monetary policy maintains its restrictive course.
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