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Updated 18:12 18/05/21

Gold bears warned against complacency as Dollar price drops

By Liam Sheasby, News Editor

28 Aug 2018

  • The current stock market bull run has lasted longer than the infamous Dot Com bubble (1995 - 2001)
  • Gold prices are shorting like they did as the Dot Com bubble wound down
  • Investors are desensitised from reacting to geopolitical strife due to Trump’s behaviour
  • Gold reaches 2-week high thanks to the weaker US Dollar

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The investment bank BMO Capital Markets has issued a note to its clients, urging them to be cautious rather than complacent in the face of gold’s low prices. The warning, published prior to the US Dollar weakening on Monday, suggested investors were too exposed to risk in the markets in the event of the US Dollar weakening.

The note by BMO Capital Markets said: “Volatility in gold prices is at its lowest level since 2001 – when the dot-com bubble was unwinding – such that the last four months have seen steady decline. Historically, when prices have exhibited such a trend it’s been largely due to headwinds from a stronger USD.

“In our view, with speculative short positions at record highs implying trend projection, market participants run the risk of being caught on the wrong side of any reversal in price
action with China-US trade friction continuing to escalate.”

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So far, the combination of economic and fiscal policies is benefitting the US Dollar. American fiscal policy comes in the form of interest rate rises, courtesy of the Federal Reserve. The economy is growing, so interest rates are rising to keep a lid on inflation. This has been quite strict from the Fed, with little time between inflation data and rate rises.

The economic policies come from the Trump administration, who have both cut taxes but also orchestrated a huge infrastructure programme which requires mass investment into the economy.

Trump’s approach is a loose one because while the US Government is spending more than it’s collecting, America is now very attractive to foreign wealth. A recent report from Brown Brother Harriman, a New York bank, cited US Treasury data and stated that $417.4 billion US assets were bought in Q2 this year – the most in any quarter for a decade.

“In the simplest terms,” says the report “that inflow of cash means foreigners are buying dollars [and] pushing up the value of the greenback. It will likely make the U.S. economy grow even faster than it would have done.”

That’s not to dismiss the tighter policies of the Fed though. Rate rises are a sensible indicator to investors that an economy is stable and a reasonable place to use their funds, and it’s the combination of both the loose and strict policies

The result of these policies is that the gold price hit an 18-month low in Dollar terms as of August 13. Gold typically moves in the opposite direction of the US Dollar, as well as having negative correlation to interest rate rises, but gold’s safe-haven status is what normally bails it out – especially in the face of strong geopolitical tensions like those between the US and China over trade tariffs.

- - -

One of the side effects of the Trump presidency is the desensitisation of investors. The world is so used to Trump drama that even serious things such as international disputes with other superpowers are considered not worth a reaction. This is an opinion held by the CEO of the Perth Mint, Richard Hayes.

“The world, to some degree, has been quite used to bad news. If you were to go back seven or eight years, any one of the trade wars, or what’s happening in the Middle East, or China, Brexit, the rise of the far left and far right, any one of those events would have been enough to make a fairly significant impact on volatility of prices of precious metals.”

The proof is in the fact that the stock markets are at record levels presently, while gold shorts are at the same level they were in 2001 when the Dot Com bubble was winding down and the stock market was becoming less attractive by the day. Today the Standard & Poor 500 Index surpassed the 2,900 points mark – a new record only days since the S&P reached the previous record – while the Nasdaq and Dow Jones remain tantalisingly close to their own records.

- - -

There are four aspects that investors should consider when questioning how gold will make its comeback:

1) A weaker US Dollar. The US Dollar is strong, and the US economy is also doing well, with the Federal Reserve predicting 1 or 2 further interest rate rises this year and likely a couple in 2019 too. While these planned fiscal actions are unlikely to change, the Dollar has benefitted from the US/China trade war, as well as other trade disputes. The agreement with Mexico at the start of this week timed with a subsequent drop in value for the Dollar. As these disputes come to an end, so will the inspired demand for the Dollar – even if it’s a minor loss in price.

President Trump is known to prefer a weaker Dollar. At the turn of the year he was praising the lower value because it would make US exports more competitive with the rest of the world and help fix their trade deficit, which in turn makes investment and lending in the USA more attractive.

Fast forward eight months and Trump says he likes the stronger Dollar but criticised Jerome Powell (Chairman of the Fed) over this year’s interest rate rises and says that he feels the Eurozone and China are manipulating their currencies. This talk worries investors, who then back out of the Dollar. Their desire to jump ship means they must accept a lower price for the USD, and so it devalues.

Trump’s ploy is obvious, and according to Neil Wilson of it will “produce diminishing returns” for the President. “I think on this one the market will come round again and the dollar bounce back, but nonetheless it does appear the market is worried that the president will exert influence on Fed policy.”

2) Increased demand. This is achievable given the Dollar’s strength is making gold more affordable, but that’s only in Dollars. Other currencies – such as the Turkish Lira or the Rupee – are experiencing high prices for their gold. India specifically is expected to drive gold prices up by the end of 2018 due to the wedding season and other religious festivals, but equally the country is prone to monsoons and typhoons. Treacherous weather has already hit Kerala – one of the keenest regions for gold – to the point that people are more likely to sell rather than buy this year, in order to foot the repair bill.

3) Reduced supply. This is already happening, with South African mining firms announcing shaft closures, mine closures, and job cuts across the country. Easy access gold is dwindling, and the more difficult gold is not cheap to access. As production levels reduce, demand for what’s left drives up prices.

4) A Gold short squeeze. Shorting is a market term used to describe short selling; investors selling what they don’t own (or have borrowed) because they believe it will decrease in value. They sell it for the current price and then buy it back when it drops, cashing in on the difference as their profit.

Shorting is a common market practice, but if the price of gold were to move higher due to one of the above reasons then the short becomes unprofitable. Investors will quickly buy back so as not to hurt their returns and this adds to the demand driving prices up; either making the price rise faster or pushing it higher.

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