- What’s moving gold prices up.
- What can happen to gold in the short to medium term.
- And how to use gold as a hedge in this environment.
What’s Moving Gold Prices Up
When interest rates go up, gold—as a non-yielding asset—is supposed to go down, but we haven’t seen that in the last 12 months.
Gold prices are up almost 10% over the last 12 months.
The reasons behind gold’s strength lie in President Trump’s hard line new staff, like John Bolton, which may lead to new issues with Iran just as things with North Korea might be easing. Further, despite what is hopefully just noise as I don’t like wars, something more fundamental might be driving some players to increase their positions in a safe haven like gold.
Higher interest rates don’t just mean higher returns on Treasuries as the higher returns increase the burden on all those in debt. Therefore, some are already positioning themselves for an economic slowdown that could be triggered by higher interest rates.
Given that the U.S. deficit continues to get larger and higher interest rates certainly don’t help, foreign investors have started to move away a bit from U.S. denominated debt.
Higher interest rates are also negative for consumers and despite the extremely good economic data coming in, credit card and auto loan delinquencies are rising.
The increased pressure on the government and consumer coming from higher interest rates might erode the benefit coming from economic growth and as we are in the late part of the economic cycle, where debt has only been accumulating over the past 8 years, we might be into for another round of deleveraging.
What medicine will central banks administer? Well, probably do the same thing they’ve done in the past: print money to pump as much liquidity into the system as possible. If that happens, we will see an explosion in precious metal prices.
What Can Happen To Gold In The Short To Medium Term
So, the situation is one where more and more people believe higher interest rates will put a burden on the highly indebted economies. Total debt in the U.S. is 10 times higher than it was 35 year ago when interest rates started to decline and 25% higher than it was in 2008.
What many expect and are hedged on, including myself, is much more quantitative easing rounds when the next recession comes. Lower interest rates, perhaps even negative interest rates, bond and perhaps even stock market purchases to bring in more liquidity. When that happens, there are two scenarios for gold. One is where gold appreciates in relation to the amount of money inserted into the economy as has been the case over the last 10 years. The other scenario is one where people lose faith in the global fiat currencies and gold explodes to levels we can’t even imagine now.
I hope that scenario doesn’t happen, but with the rise of populism and if there is ever a deleveraging of those huge piles of debt, it will for sure will be painful and might further fuel populism and who knows what else.
How To Use Gold As A Hedge In This Environment
Warren Buffett doesn’t like gold because it isn’t a producing asset, but he does own a lot of cash. Ray Dalio on the other hand says that if you don’t own gold, you don’t know history nor the economics of it. Therefore, one should be exposed to both gold and silver with at least a part of their portfolio. There are a few ways you can do that:
- Own physical gold or silver (storage costs).
- Own a physical gold ETF (trading costs and fees).
- Own gold miners (not necessarily a perfect correlation).
Perhaps the best thing would be to have a mixture of the three – physical metal for the absolute safety, ETFs for rebalancing and liquidity, while gold miners are the ultimate bet as their margins would improve multiple times if gold increases, let’s say 50%.
However, you have to expect much more volatility with miners as the mining environment is the wild west of investing.
What’s also interesting is that over the last 12 months while gold is up 8%, the GDX is actually down which might indicate a buying opportunity as we’ll probably start seeing higher earnings and perhaps even higher dividends if gold price continue to surge.