The gold market started to heat up as the price of SPDR Gold Trust (NYSEARCA:GLD) rose by 2.5% since the beginning of the year. China's economic woes and the decline in long term interest rates helped bring up the price of GLD. But the greenback is holding back the recovery of gold. Let's see how these opposing forces play out for GLD.
Lower long term interest rates
The grim outlook for China and even more so the potential adverse ripple effect a slowdown could have on the rest of the world has resulted in a rise in demand for safe heaven investments - most notably U.S. treasury yields, which could partly explain the drop in LT yields: 10 year treasury notes dropped to 2% -- this is the lowest levels since mid-October 2015. But that's not all. The bearish market sentiment has also persuaded people that the Fed will only raise its cash rate once this year, as indicated in the table below.
The table shows the weighted-average estimate, based on the data derived from the bonds market, of the Fed's cash rate by the end of the year. It also presents the revisions over the past several weeks. As of January 16th, the market expects the average rate will be 0.6%, which means a 0.25% increase. Only a few weeks back, the rate was expected to rise by close to 0.5% or two 0.25bp hikes. These estimates are likely to change as market volatility remains elevated.
But if the market is right and the Fed doesn't raise rates - perhaps over concerns of a strong U.S. dollar, low inflation and the impact of tighter policy on other major economies - this could bring further down LT interest rates, which should positively impact GLD prices. And the recent bearish market sentiment has also raised the demand for GLD: gold hoards of the ETF rose by 2.5% to reach 657.9 tons of gold - the highest level since the end of November of 2015.
At the end of the month the FOMC will meet for the first time. If the Fed keeps its line of policy without making any promises of slower rate hike - despite the latest developments in China - this could cool back down the gold market. After all, while the stability of emerging markets is important, it's not the Fed's prime concern. In any case, the Fed's policy measures may be ill equipped to stabilize global financial markets -- as stated by former Chairman of the Fed Ben Bernanke in a recent article.
The comeback of the greenback
On the other hand, GLD is also being pressured down due to the strengthening of the U.S. dollar against the major currencies - with the exception of the Japanese yen.
Source: FRED and Google finance
As presented above, the trade weighted U.S. dollar index didn't do much throughout November and December. But as 2016 started so did the greenback resumed its rally. This is also related to economic woes from aboard - mostly in emerging markets - and the tighter monetary policy of the Fed. And even if the Fed doesn't raise rates at all this year, the U.S. dollar could still further appreciate as major central banks continue with their expansionary monetary policies to devalue their currencies. This week, the ECB will convene for its first policy meeting of the year. Last time - back in December - the reaction to a cut in the deposit rate and an extension of QE wasn't positive as the markets expected more action from Draghi. This time, the markets don't expect much; so if ECB President manages to surprise the markets with more steps towards stimulating the EU economy, this could devalue the Euro. For precious metals in general and GLD in particular a stronger dollar could weigh on their progress and partly offset the growing demand for bullion in times of economic uncertainty.
The latest drop in the expectations of a rate hike has fueled a rally of precious metals. And I think that over the very short term if the bearish market sentiment continues, this could keep pushing up the price of GLD. The FOMC may acknowledge the recent developments in China, but I doubt its members will show any change in their stance about their policy. And unless there are clear signs of a possible slower rate hike pace in the coming months, the latest recovery of GLD won't last long. For more please see: What's Up Ahead for Silver in 2016?
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