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How to Read Gold’s Short-term and Long-term Barometers
Thermometers tell you today’s temperature, but barometers are the best source for seeing tomorrow’s weather today, based on the conflicts between powerful high and low pressure systems. It’s the same with gold. Here are three short-term barometer readings, along with three other longer-term indicators:
Short-term Barometers: The Election, the Fed and the Dollar
Gold recently corrected from summer prices over $1,300 per ounce down to the $1,250 to $1,270 range, based on changes in the readings of three short-term barometers – the election, the dollar and the Fed.
First, the election trend: As we wrote two weeks ago, gold is likely to rise much higher with a win by the unpredictable candidate, Donald Trump, vs. the “more of the same” establishment candidate, Hillary Clinton. After damaging leaks and a confrontational series of debates, the likelihood of a Trump victory has faded fast, sending gold down sharply. As of Friday, October 21, two widely-watched polls were overwhelmingly betting on a Clinton victory. In Britain, where they bet real money on our election, Trump has only a 16% chance to win vs. 83% for Clinton. The forecast at fivethirtyeight.com now sees an 87% chance that Clinton will win vs. 13% for a Trump victory. That compares with a 55% likelihood of a Clinton victory as of September 26, when gold traded at $1,340, due in part to Trump’s 45% odds to win.
Second, the likelihood of a Federal Reserve interest rate increase later this year is rising. The release (on October 12) of the Fed’s minutes for their latest (September 20-21) meeting of the Federal Open Market Committee (FOMC) revealed great dissention in their ranks regarding monetary policy. Recent FOMC member comments have also indicated that a mid-December interest rate increase is now more likely. The Chicago Mercantile Exchange makes a market in Fed Funds futures prices. As of October 21, the CME poll calls for a 70% chance of a rate increase and 30% for status quo at the December 14 meeting.
The third barometer is the U.S. dollar. Gold tends to go down when the dollar strengthens, and it rises when the dollar is weak, since gold is universally quoted in U.S. dollar terms. By the same token, gold tends to rise faster in foreign currencies when the dollar is stronger. Due in part to the Fed’s likelihood of a rate increase in December, the dollar has strengthened sharply over the last month. From a 95.1 reading on September 26, when gold traded at $1,340, the Dollar Index is now to 98.7, up about 3.8% in a month.
In the last month, gold is down a little over 5% in U.S. dollar terms, but the lion’s share of that decline is based on a stronger dollar. By contrast, gold is only down only about 2% in euro terms in the last month.
In light of the negative interest rates in Japan and in most of Europe, a rise in dollar rates will likely draw trillions of dollars in foreign exchange “flight capital” from the rest of the world into U.S. dollar accounts.
Longer-term Barometers: Deficits, Real Rates and Supply/Demand Trends
Gold soared to its latest highs in 2011 based in part on historically-high budget deficits during President Obama’s first term, when the federal deficit topped $1 trillion each year. Then, the economy recovered (sort of) and the gold price declined during President Obama’s second term. Now, that trend is beginning to change. The deficit rose in fiscal 2016 (ending September 30) for the first time in the last five years.
In 2016, as this table shows, the deficit and gold both rose. The 2016 federal fiscal year is 34% larger than 2015’s deficit. Compared to GDP, the 2016 budget represents 3.2% of 2016 GDP, up from 2.5% in 2015.
Neither Presidential candidate has seriously addressed the rise in federal spending or has a plan to halt the rise in entitlement spending. Both candidates have offered a large array of new spending plans to widen the deficit. The following chart projects growing deficits over the next decade no matter who is President.
The second long-term barometer is real interest rates – defined as the nominal interest rate minus inflation. When real rates are below zero, gold tends to rise, historically. (The Consumer Price Inflation is up 1.6% in the last 12 months, so any interest rates below 1.6% represent negative real rates.) As the following chart shows, rates were negative from 2009 to early 2015, then turned briefly positive before falling below zero again in late 2015, when gold bottomed at $1,060 last December after a rate increase.
Negative real rates are likely to continue since the Fed will only raise rates if they see inflation at or near their 2% target. Raising nominal rates to 1% or even 1.5% would still represent negative real returns, giving gold an advantage over cash in the bank earning what amounts to an ongoing erosion of principal.
The third and most important barometer is supply and demand – which is the closest analogy to the high-pressure and low-pressure systems measured in the changes of a barometer’s readings.
Due to several years of declining gold prices – it’s now more than five years since gold’s peak price in September of 2011 – many gold mining operations have closed down for lack of profits. We won’t know if gold production peaked in 2015 until 2016 statistics are in, but it is possible that gold production already peaked in 2015, partly because it takes 20 years to put turn a gold discovery into peak production:
On the demand side, as we have reported recently, we’re seeing rising demand for gold exchange-traded funds (ETFs) this year, a resumption of central bank gold buying and a welcome relief from two years of weak monsoon rains (and intrusive government regulations) in India, which had put a two-year damper on gold demand in that traditionally gold-centered culture. At latest report, we’re seeing rising gold demand in both China and India, the two nations responsible for about 50% of annual physical gold demand.
The short-term barometers are important, but the election will soon be over and the dollar won’t rise forever, so these long-term barometers are more likely to fuel gold price increases in the years to come.