Gold is facing a perilous path forward in more ways than one.
For one, central banks are beginning to step away from the liquidity punch bowl that has pushed markets to record highs. The Federal Reserve is shrinking its balance sheet and raising interest rates, and the European Central Bank is beginning to taper bond purchases. A scenario like this makes it difficult for a non-interest bearing asset like gold to perform well.
“A more normal global monetary system is a net-negative for gold,” said John LaForge, head of real assets strategy at the Wells Fargo Investment Institute. “Gold, like many other commodities, typically performs best with loose monetary policies, including extra low real interest rates. The more ‘normal,’ or less accommodative, global monetary systems become, the harder it will be for gold to rally.”
Gold may find support from lower real rates as U.S. inflation peaks in mid-2018 as consumer prices will likely ease in the second half of next year, and nominal rates will move higher presenting downside risk for the metal. But there’s no guarantee the Fed’s hikes will cap gold’s upside, especially considering geopolitical uncertainty.
When interest rates are low, it’s cheaper to hold non-interest bearing assets like gold, which is why higher rates are negative for it. While it’s true that gold surged more than 50% during the last tightening cycle from June 2004 to June 2006, it’s also true that at the time the predominant concern was that the banking system was getting out of control and that inflationary pressures were more pronounced. The situation now is considerably different.
“It seems unlikely that inflation goes meaningfully above 2 percent to 2.5 percent anytime soon,” said Troy Gayeski, a senior portfolio manager at SkyBridge Capital. “As the Fed tightens further, real rates in the U.S. will gradually creep up to positive territory. Over time, one would suspect that as long as inflation stays contained, we’ll at least have modestly positive real rates in the U.S. It’s very hard to see gold doing tremendously well in a tightening environment.”
What’s also different now from the previous tightening cycle is that, while there are certainly concerns about geopolitical conflicts, a weaker dollar, even the threat of nuclear war with North Korea, younger investors aren’t attracted to gold as a safe haven asset. Instead, they are looking to cryptocurrencies like bitcoin.
Investors are attracted to cryptocurrencies for many of the same reasons investors have been drawn to gold in the past. Cryptocurrencies are anonymous, divisible, and can’t be debased by governments like paper dollars can be.
And the big draw to cryptocurrencies this year isn’t just that they offer anonymity and are independent from government, but also that most have surged more than 100% this year.
Bitcoin and Ethereum in particular have produced substantial gains. On January 1 of this year, bitcoin was $997. Today, Thursday, it trades at just over $7,900, that’s a nearly 695% gain. And Ethereum has achieved over 37-fold on occasions this year.
With such massive gains, it’s no wonder cryptocurrencies have gained a rabid following, and despite the Fed’s tightening, prices continue to rise to new heights, which isn’t true for gold.
Being faced with both tightening monetary policy and cryptocurrencies as the hot new commodities, it isn’t hard to image a very rocky future for gold.