Gold's Perfect Storm

| About: SPDR Gold (GLD)

Summary

Fundamental factors that propped up gold in 2011 and 2012 are gone.

Today there is no ZIRP, inflation is on the low end, and QE is over.

Fear can be reintroduced into the market to push gold higher.

Jobs reports and oil could come together and create the perfect storm for gold.

In my previous articles I talked about why gold (NYSEARCA:GLD) is getting less and less attractive (read Trim Your Gold Positions). Since the economy is doing quite well, fear seems to have evaporated, which should lead to poor performance for gold. Still, gold has risen substantially in 2016. How do we explain that?

Looking at the long-term chart, we can see that gold plateaued in late 2011 before it started to fall in 2013.

Click to enlarge What happened in 2011 and 2012? Inflation was on the high end, ZIRP was still in effect, and the Fed was still pursuing QE!

Click to enlarge

Fundamentally speaking, all of the above factors should have contributed to a higher gold price. Of course, reality tells a different story. Why? As I've mentioned before, one of the biggest factors affecting gold is fear. Unfortunately for gold investors, there was no fear in the market, as evidenced by strong equity performance in 2013, during which gold lost 27%.

In 2016, the fundamental factors that supported gold are gone (i.e. no more ZIRP, no more QE, tamed inflation), but gold climbed anyway. As we can see, fear alone can be a powerful force. Credit spreads spiked and there was a lot of commotion abroad (e.g. Brexit). While none of these factors affect gold on a fundamental level, people were afraid, so gold benefited. In my previous article I said that fear has left the market, but can fear be introduced again? Yes, and I believe that gold investors should pay attention to the two factors below.

Jobs Report

While job numbers fluctuate a lot, the market has a tendency to focus on the most recent report. The idea is that one bad month foretells another. Based on history, we know that this is not the case under typical circumstances.

Click to enlarge The labor market is the foundation of the economy. A poor labor market will result in lower spending, which in turn makes the labor market even worse. This downward spiral always begins somewhere, so it's understandable that investors get nervous whenever payrolls fall.

Oil

The justification for oil is a bit more convoluted. I believe that lower energy prices will ultimately benefit the economy. Imagine if we could get all the oil we want for free! Unfortunately, the reality is that markets react negatively when oil gets too low. The spike in credit spreads earlier in the year corresponded to oil's multi-year low in February:

Click to enlarge

Lower spreads lead to higher cost of debt, higher cost of debt leads to lower equity prices, lower equity prices cause panic selling, and then the fear will feed on itself. So even though low oil prices create tangible benefits from the economy by freeing up cash for consumers, if it falls too much, chaos will ensue. If you are interested in learning why I believe that oil could be a big problem, you can read my latest update here.

Note that a temporary decline in jobs or oil will not have negative consequences by themselves. It's the way that the market thinks about them that creates fear. Considering that many gold focused investors are highly skeptical of the current economic condition, they may want to keep their eyes peeled for possible signs that point to a simultaneous deterioration in the labor market and oil. Together, they could create the perfect storm that will send gold higher. Thus far, I only have a problem with oil, which could trigger a bear market by itself as we discussed earlier.

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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.