The gold price puzzle

Various explanations have been given for the metal’s current behaviour, but no clear picture has emerged

Sherlock Holmes famously solved the Hound of the Baskervilles case by asking: “Why did the dog not bark?”

The same could be asked of the gold price. Global stock markets are, with some notable exceptions, riding at or close to record highs, inflation is widely thought to be on its way back, and the world seems to be on the brink of a global trade war.

Yet not only is the gold price not rising, it is actually falling. The gold price in dollar terms has just dipped below its year-to-date level of $1,224 an ounce.

What’s going on here?

The most widespread answer to that question is: “rising interest rates”. The yield on the global benchmark for interest rates, the US 10year treasury bond, breached 2.5% earlier this year, breaking a trend evident since the global financial crisis in 2008. It is now higher than that, at 2.9%, and Jpmorgan CEO Jamie Dimon said recently it’s likely to go up further and breach 5%.

“US interest rates are like kryptonite for the gold price,” says one gold industry insider on condition of anonymity. The holders of both gold and US treasuries are often investors for the same set of reasons — both are a hedge against market volatility.

The difference is that since gold pays no interest or dividends, it becomes less attractive to these kinds of investors when interest rates rise, since bond investors will at least be getting a small yield for their investment whereas they would get nothing for gold.

Hence, this year at least, the declining gold price is logical.

Gold has other problems too.

Increasingly, it is being seen in the same basket as commodities in general. The link between, say, the copper price and the gold price is stronger now than it has been at some periods in the past.

Speculative investors are pressure on the gold price.

US Commodity Futures Trading Commission data shows that hedge funds have almost halved their net bets on gold this year, and they are now at their lowest levels in over a year. The Wall Street Journal reports that flows into goldbacked exchange funds have remained tepid and that demand for American Eagle gold coins, a proxy for physical demand, recently hit a multiyear low.

Gold companies have bucked the trend

putting downward somewhat in the past, but most followed the gold price down this year. Gold Fields is down about 8% over the past year, Harmony and Anglogold about half that.

And yet, as always with gold investing, there is a contrary voice.

For this argument to be convincing, a longer time frame is necessary. The gold price has traded in a fairly narrow frame by its standards for the past five years, somewhere between $1,250 an ounce and $1,000 an ounce. By historical standards, its current level is rather high.

For much of the first decade of this century, the highest it ever got was $700 an ounce. In the wake of the 2008 financial crisis it just exploded, and reached its highest level ever of $1,828 in August 2013.

The argument in favour of investing in gold now is well put by Will Rhind, founder and CEO of US ETF investment company Graniteshares. “Typically what happens when we see a market correction is that people don’t immediately flock to gold, and the reason for that is that they are trying to assess their position in current portfolios and have to liquidate assets to meet redemptions from clients.”

He said in an online interview: “We saw this in 2008. Gold initially sold off, along with the rest of the market, but subsequently recovered and ended positive for that year, and then went on to post [a record] high.”

“Typically gold does not react at that particular moment, but follows through later [when] people begin to reallocate capital as their perception of the market changes.”

This perspective makes Rhind claim that the best is yet to come for gold.

“The past 30 years of disinflation are now over and we are beginning a new inflationary phase that is positive for gold and for commodities more broadly.”

Like many gold bugs, Rhind makes the point that gold acts as a hedge against inflation because the supply of gold can’t be readily increased like the supply of money.

Yet the comparison with 2008 looks dodgy. Though Donald Trump’s administration might disturb markets with threats of a trade war, particularly with China, how that will play out is yet to be seen.

Global markets are overvalued, and inflation is on the rise, but corporate profits are strong, particularly in the US, partly as a result of Trump’s reduction in corporate tax.

The dog has not yet barked, and it has not barked when it should have.