Gold is supposed to be a reliable hedge against inflation and economic disasters, but right now it’s stuck in the mud. When will gold shine again?
- A strong U.S. dollar and rising interest rates are creating headwinds for gold.
- The dollar and interest rates could still go higher, but eventually, the Fed will need to suppress them for the sake of the economy.
- Gold tends to spend a lot of time stuck in the mud and then explode in price very quickly. Our advice? Get in before the price doubles again. Everyone else is going to buy at the peak.
Why is Gold Falling?
Gold continues to face a strange combination of tailwinds and headwinds. Even as U.S. inflation rockets toward double digits, gold appears stuck in the mud.
Two things are responsible for gold’s recent downtrend: rising interest rates, and a rising U.S. dollar. As gold approaches its $1,680 support level, what should we understand about these trends? Is it time to buy or sell?
Rising Interest Rates
Gold does not pay interest, so it is always competing with interest-bearing assets such as bonds. Over the last few months, the Fed has intentionally cranked up interest rates at a record pace. The chart below shows the rising interest rates on U.S. treasuries over the last year.
Creditors love high interest rates, but debtors hate them. The U.S. government, currently carrying over $30 trillion in debt, is the biggest debtor in the world. If rates get too high, the government will be forced to push all their tax revenue into interest payments.
For that reason, the Fed cannot let interest rates get too high.
Rising interest rates also hurt the economy and stock prices. The Fed has an interest in protecting the economy and stock market, which limits how far rate hikes can go.
A rising U.S. dollar is also responsible for suppressing the gold price.
Gold is priced in U.S. dollars across all major exchanges. When the dollar rises against foreign currencies, gold gets more expensive for foreign investors.
The dollar also competes with gold as a safe haven asset. When exiting risk assets, investors typically choose between bonds, gold, or cash. This year, most people have chosen cash. However, there are two reasons why this dynamic is unsustainable.
Reason number one: Inflation
Cash is losing purchasing power at a record pace, which limits the amount of time investors are willing to sit in cash. Investors, both individual and institutional, are looking for an opportunity to redeploy their cash. If the economy plunges into a recession, or if inflation remains high, stocks and bonds look pretty dismal.
Reason number two: No one likes a rising dollar
In some ways, a rising dollar is good for the U.S. economy. For example, U.S. consumers have more purchasing power against international goods.
However, the threats of a rising dollar probably outweigh the benefits.
A rising dollar hurts the revenue of multinational companies. When they receive foreign currencies overseas, they must convert them to dollars at a reduced rate.
A strong dollar also hurts emerging market economies. Copper, oil, gold, and many other commodities are priced in U.S. dollars. A rising dollar makes commodities more expensive in emerging markets, worsening inflation and adding pressure to economic output. Emerging market economies also have dollar-denominated debt. When the dollar goes up, their debt becomes more expensive to service.
The rising dollar has a destabilizing impact across the entire globe.
Board the Rocket
Gold’s lackluster performance can be frustrating for new precious metals investors. Isn’t gold supposed to hedge against economic disasters? Isn’t this the perfect environment for gold to take off?
The answer is yes. But, gold investors must face the same tough reality they have faced for 50 years. Downtrends are long and boring, while uptrends are short and explosive.
Stocks are the complete opposite. Bull markets are slow and steady, while bear markets are short and violent.
When it comes to gold investing, very few people have the patience to withstand the downtrends and capitalize on the uptrends. Gold spends a lot of time stuck in the mud, preparing for explosions in price. Most investors ignore all the entry points during bear markets and scramble to buy as much gold as possible during bull market peaks (think 1980, 2011, and 2020). This takes the most important rule of investing – buy low, sell high – and throws it out the window.
Our advice: don’t be that guy. When the gold price finally decides to take off, most investors will be late to the game. Stack up on gold when everyone else shuns it.
Gold investing requires an uncomfortable amount of patience. But, when things start to go your way, they go your way fast. Right now you have the opportunity to board to rocket. Better to get on now than at the peak of its flight path, when everyone else will be clamoring for a seat. That’s when you can calmly step off, collect profits, and go merrily on your way.
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As always, thank you so much for reading – and happy investing!
The world isn’t prepared for a wave of sovereign debt defaults (Financial Times)
Strong Dollar Fuels Pullback in Commodity Markets (The Wall Street Journal)
Global Central Banks Ramp Up Inflation Fight (The New York Times)
Diverging Jobs Data Raise Questions About Labor Market Health (The Wall Street Journal)
Housing Boom Fades World-Wide as Interest Rates Climb (The Wall Street Journal)