While other commodities are plunging, they still have a purpose. Gold has very little real world purpose (about 10% of new gold goes to industrial uses) and jewelry demand has waned across the world. Gold is widely seen as a safe-haven investment, but that’s not always the case. This is why gold presents such immense danger for investors over the next few years. The reason for this is that we’re currently in a deflationary environment. Gold is only safe in inflationary environments.
Disclosure: I own DUST, which shorts gold miners.
Gold and the Economy
Think back to 2008. On Aug. 31 of that year SPDR Gold Shares (GLD) traded at $85.07. On Sept. 30, 2008, it traded at $71.34. This was at the very height of the financial crisis. Why did GLD stumble? Because we were in a deflationary environment. The reason gold, and GLD, moved back up for months and years to follow was because the Federal Reserve stepped in and stoked inflation. (For more, see: What Drives the Price of Gold?)
At that time, the Fed had plenty of ammo and was highly effective – at least in regards to stoking artificial inflation. Today, that’s not the case. If and when deflation hits, the Fed might come to the rescue by moving interest rates lower or even by implementing negative interest rates, but there’s still not many places to go compared to 2008. Any inflationary spikes will be short lived, which means any gold rallies will not be sustainable.
If you don’t believe deflation is upon us and the economy will improve, then the Fed will hike interest rates, which will also be bad news for gold. Either way, gold is trapped and likely to move lower over the next couple of years. But it’s not all bad news for traders. Since investors move to gold when stocks falter, gold can present short-term trading opportunities that can produce significant gains. However, the end result isn’t likely to be good. Once the smoke clears in either direction - bullish or bearish with deflation - gold is going to take a hit. (For more, see: Breaking Down the Federal Reserve's Dual Mandate.)
Some people are investing in gold because they don’t believe in the U.S. dollar. For starters, the Federal Reserve hasn’t been as dovish as the European Central Bank and Bank of Japan, which should lead to better results for the dollar over the next few years. You also have to consider a deleveraging process that, based on supply and demand, will also increase the value of the U.S. dollar.
To play devil’s advocate, let’s say the U.S. dollar failed. Gold wouldn’t be its replacement. Iran just announced that it wants to abandon the U.S. dollar and switch to the Russian ruble, euro, or Chinese yuan. That’s just a small note. On a larger scale, we’re slowly but surely moving toward a cashless society. If we’re not going to use paper money because it’s seen as an outdated form of trade, then moving to gold would be archaic. Everything will eventually move digital.
Jeffrey Currie, global head of commodities at Goldman Sachs Group, Inc. (GS), recently stated that systemic risk from oil, China, and negative interest rates is very unlikely. He went on to state that the sell-off in stocks related to the plunge in oil won’t continue because the fear trade related to oil is over. In regards to gold, he has a three-month target of $1,100 an ounce and a 12-month target of $1,000 an ounce. (For more, see: The Top 3 Gold ETFs for 2016.)
The gold miners have been on an almost relentless tear over the past several weeks, but the rally relates to momentum not value. Here are some examples. Barrick Gold Corp.'s (ABX) fourth-quarter results weren’t what you would call impressive. Revenue slid 10.8% year over year, and adjusted EPS came in at $0.08 vs. $0.15 in the year ago quarter. In 2016, the company expects to produce 5.5 million ounces of gold at $775-$825 per ounce. In 2015, it produced 6.1 million ounces of gold. Newmont Mining Corp. (NEM) didn’t impress either, with revenue and adjusted EPS declining 10% and 76.5%, respectively. This was due to lower metal prices and divestitures.
The Bottom Line
The only real catalysts for gold are panic/confusion in the stock market and the Federal Reserve turning dovish. While both catalysts have the potential to lead to large short-term gains, neither will lead to sustainable gains. It’s a lose/lose for gold. If the global economy is entering a deflationary cycle, then gold will take a significant hit. If the global economy is improving, the Fed will tighten and gold will take a significant hit. (For more, see: The Top 5 Gold Stocks for 2016.)
Dan Moskowitz currently owns DUST. He does not have any positions in GLD, GS or BNS.