The Inflation Expectations Play on Gold in 2018
Inflation and the Fed
As discussed in the previous part of this series, the Fed is keenly looking at inflation data to decide on the frequency of rate hikes in 2018. While the Fed kept on stating for some time that the weaker inflation data is transitory, recently it said low inflation is “a mystery” and an “unexplainable surprise.”
The minutes for the Fed’s December 2017 meeting showed that Fed officials are still worried about low inflation. However, the Fed believes the recent tax changes should boost consumer spending, which, in turn, should drive the inflationary pressures.
Inflation firming up
While inflation has remained low for several months, the most recent readings might suggest that it has started to pick up. The latest consumer price inflation (or CPI) came in at 2.2% while headline personal consumption expenditure (or PCE) inflation came in at 1.8%. The Fed’s preferred measure of inflation, core PCE, came in at 1.5%, which is below its target of 2.0%. The producer price inflation (or PPI) came in over 3%, which is a multiyear high. As PPI remains high, chances are that this inflation will pass onto consumers, resulting in higher consumer price inflation as well.
Inflation and gold
Since gold is often used as an inflation hedge, firming up inflation is a good prospect for gold. On one hand, rising inflation should encourage the Fed to increase rates. On the other hand, it should drive investors toward gold (GLD). In such an event, key gold stocks (GDX)(GDXJ) like Gold Fields (GFI), IamGold (IAG), Kinross Gold (KGC), and New Gold (NGD) should also benefit. While company-specific factors led to annual gains for IAG, GFI, and KGC, NGD saw losses amounting to 6.0% in 2017.
The Safe-Haven Status into Play for Gold in 2018
Protests in Iran
A few scattered protests in Iran on December 8 over the cost of eggs quickly escalated into a countrywide movement. Iranians are now protesting in large numbers, calling for an end to corruption, unemployment, high inflation, and oppressive government.
These protests mark the biggest opposition movement since the Green Revolution in 2009, when Iranians protested the re-election of then-President Mahmoud Ahmadinejad. While the current protests have started to ebb, the anger among the public doesn’t seem to be waning. Analysts feel that, this time, the protests seem to be different. These protests didn’t start in Tehran, nor have activists been the usual elite. In fact, these activists are mostly working and young people, which might suggest that the protests could mark a longer period of unrest.
While there isn’t any real news regarding the US and North Korea, fears of a conflict are on the rise. North Korea continues to launch missiles and perform weapons testing. Statements out of North Korea don’t seem to be simmering down, which could mean the possibility of a conflict at any time.
Geopolitical tensions and gold
History serves as a guide that when geopolitical tensions rise, investors seek refuge in safe-haven assets—including gold. In September 2017, after North Korea test-fired missiles, gold’s price zoomed past $1,300 per ounce level. Any conflict going forward could support gold prices, which would also be positive for gold investments such as Barrick Gold (ABX), AngloGold Ashanti (AU), B2Gold (BTG), and Yamana Gold (AUY). Collectively, these four stocks form 13.7% of the VanEck Vectors Gold Miners ETF (GDX).
Equity Market Correction the Outlook for Gold
Investors are well aware that US equity markets (SPY)(SPX) have hit higher highs seemingly every other day. The Dow Jones Industrial Index (DIA)(DOW) made a record of 70 all-time high closes. The SP 500 rose 19.4% to hit record highs. Volatility, on the other hand, has remained quite low in 2017. High volatility is usually good for gold prices. Now, after a string of highs, a correction in the market might be on the horizon.
Correction in the cards
Blackstone Group’s vice chairman, Byron Wien, predicts that 2018 will see a correction of 10% in the SP 500. He said speculation will get ahead of itself in 2018, leading to a short correction. Many other experts have also started to worry that stock prices might be too high and that positive news for 2018 might already be priced into the equity markets, which could mean downside for the markets.
The stock markets are trading at very high valuations versus a year ago. While this difference doesn’t automatically mean that the market has become overbought or overvalued, many market participants believe, since most of the positives are already priced into the stock prices, that there’s downside potential.
If this downside potential materializes, gold might be in for a treat. Investors usually flock to gold when other investment alternatives aren’t doing well. The positive sentiment for gold could also affect miners such as Royal Gold (RGLD), Barrick Gold (ABX), Kinross Gold (KGC), and Coeur Mining (CDE), which are leveraged plays on gold (JNUG).
Although royalty companies such as RGLD did well in 2017, other miner categories lagged. ABX and CDE returned -9.4% and -17.5%, respectively. KGC has been an outlier with returns of 39.9% in 2017.
The US Dollar Play It’s Influence on Gold in 2018
US Dollar in 2017
In 2017, the US dollar or USD (UUP) witnessed its worst performance since 2003, falling 9.8%. The weakness in the US Dollar Index continued, mainly due to the delay in various reforms in the United States (SPY)(QQQ) and the flattening yield curve. A flattening yield curve generally raises concerns about the long-term economic growth outlook.
The USD even started 2018 on a weaker note, sliding to its lowest level in more than three months. This fall came in anticipation of a slower pace of Fed rate hikes as inflation remains weak. But it rebounded on stronger-than-expected US economic data.
US Dollar Outlook
While there’s no crystal ball that can accurately predict the outlook for the USD in 2018, we’ll analyze some variables that can significantly influence the USD in 2018. Inflation is one of these factors. If inflation pressures build up in the US, the USD could strengthen, and vice versa.
Moreover, the performance of the US economy relative to the rest of the world also influences the outlook for USD. Global growth has started accelerating relative to the US, which could decrease the USD’s attractiveness compared to other currencies, reducing its demand and leading to a decline in value. The euro, for example, strengthened compared to the USD in 2017. It has gained the most against the USD since 2003, supported by strengthening European economies as expectations of monetary tightening from the European Central Bank (or ECB) increase.
Citibank (C) is also forecasting that the USD will decline by 5.0% in 2018 due to:
- the build-up of foreign-owned liabilities
- accelerating global economic growth relative to the US
- weaker inflation expectations
It also believes tax reform is now “substantially known and priced.”
US Dollar and Gold
Dollar-denominated assets such as gold and oil become cheaper when the value of the US dollar falls, and vice versa. As we’ve discussed in the above paragraphs, the weakening USD would be positive for the price of gold. It could affect miners positively. This bounce back in gold prices could lead to gains in the stocks of companies such as Goldcorp (GG), Randgold Resources (GOLD), Hecla Mining (HL), and Franco-Nevada (FNV). These stocks are trading at $12.8, $97.6, $4.0, and $79.9, respectively. – Annie Gilroy
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