Gold consolidates gains amid easing interest rates

Gold spent July consolidating its gains above the $1,400 level, as we appear to be approaching the potential end of several different long-term cycles that may lead to elevated risks.

Gold consolidates gains amid easing rates

Following the June breakout, the gold price consolidated gains above the US$1,400 per ounce level in July. Dovish comments from the US Federal Reserve Bank (Fed) and European Central Bank (ECB) officials supported gold. Before the House Financial Services Committee on July 10, Fed Chairman Jerome Powell described growing uncertainties; issues with trade; debt and Brexit; and the weakness of global manufacturing and investment. . Gold reached a new six-year high of US$1,453 on July 19 with further dovish comments from Federal Reserve Bank of New York chief John Williams and Fed Vice Chairman Richard Clarida, who talked of deflationary pressures and made aggressive comments on rate cuts. On July 25 after the ECB Governing Council meeting, Chairman Mario Draghi described a worsening outlook. The Fed kicked off the global easing cycle as expected on July 31 with its first rate cut since 2008.

Gold was not deterred by the US dollar, as the US Dollar Index (DXY) ended July at the top of its recent range. Interest rates, rather than the US dollar, have become the primary driver for gold. Real rates (adjusted for inflation) are near zero, or negative, for over half of the debt outstanding globally. When rates are so low, gold becomes competitive with interest-bearing investments in addition to its qualities as a store of wealth. We expect gold and gold shares to perform well for the duration of this rate-cutting cycle. If this cycle ends in recession, like in previous cycles, risks could emerge and drive gold much higher.

Silver sprang to life in July, adding conviction to the recent gains in the gold price. According to Bloomberg data, July saw record inflows into silver-backed exchange traded products (ETPs), and holdings also rose to a record high, while volume spiked higher in Shanghai commodities trading. There was no fundamental news that could account for the move, as the price of gold is usually the main driver for silver. The staying power of gold prices during the month focused attention on the extreme undervaluation of silver compared to gold. The gold/silver ratio reached a 29-year high of 93 in June, compared to the 10-year average of 66. Silver usually outperforms gold in a strong market due to lesser liquidity and a more speculative nature. For the month, gold advanced by US$4.45 (0.3%) to US$1,413.90, while silver gained US$0.95 (6.2%) to US$16.26 per ounce and the gold/silver ratio dropped to 87.

Gold stocks outperformed the metal again in July with the increased interest in the gold sector. The NYSE Arca Gold Miners Index advanced 4.6%, while the MVIS Junior Gold Miners Index gained 8.8%. When gold moves higher, the performance of smaller companies typically lags the larger companies initially. As the move continues, the smaller companies usually catch up and surpass the larger ones. Investment management firm Paradigm Capital Management analysed gold companies’ performance in the strong gold market during the first-half of 2016 when gold rallied by US$300 per ounce. Paradigm found the senior producers performed the best initially, but were surpassed by the junior producers after three months from the cycle low. Junior developers surpassed the seniors at four months, while intermediate companies outgained the seniors after five months.

Persevering towards a new high

With signs of economic strain popping up around the world and the trade war continuing to unsettle markets, the time may have come for investors to think about gold and gold stocks, which have traditionally served as a portfolio diversifier and potential safe haven investment, and position accordingly.

At their current, historically low valuations, gold stocks are well positioned to benefit beyond just that of any period of near-term elevated risk.

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