Let's be honest - you're not long gold right now. But you probably should be. Here's why.
Gold is a very interesting commodity. Supply and demand factors for gold don't really correlate well to price changes in the actual commodity. With secretive gold transactions by central banks, a black market of unknown size, and a hoarding public, gold has a lot of forces aligned against traditional fundamental analysis of the precious metal. Despite the nearly complete lack of fundamental supply and demand price response, our canoe isn't up the proverbial creek. We've got exogenous economic factors which exhibit pressure on gold's relative value fluctuations! In other words, we've got hope.
Right of the bat, we need to be honest with ourselves - gold trading is mainly driven by macroeconomic events which influence psychology regarding safety and inflation. I've dug into the numbers several times, and there are only a few things which correlate pretty strongly with gold. One of the strongest relationships I've ever found is the inverse relationship between gold and the dollar.
As you can see in the chart above, the relationship is pretty good and reliable. As the dollar increases in strength, gold tends to fall. Conversely, when the dollar weakens, gold tends to strengthen. The basic economic relationship is this - gold is priced in dollars. When the dollar weakens, it takes more dollars to purchase the same ounce of gold, therefore the price increases. This is simple, logical, and makes money - if you can predict the direction of the dollar. We're in luck - we can do just that.
On December 16th, 2015, the Federal Reserve increased interest rates for the first time in seven years. When the Fed raised rates, it set off a chain reaction which has just started to reverberate through the economy. Perhaps the most impactful result of the Fed's actions will be on the strength of the dollar. History has shown that when the Federal Reserve increases rates following a period of prolonged low rates, the dollar tends to fall by around 10%. In fact, I'm understating it here - the dollar has declined every single time the Federal Reserve has increased rates after a long period of low rates. As you can see in the chart below, we've already started our descent - the dollar is in decline.
Here's where our investment recommendation comes in. As we've previously discussed, the dollar and gold are pretty strongly correlated. Also, as we've discussed, the Fed just increased rates which will probably result in the dollar declining. As the dollar declines, gold will more than likely rally - strongly. To help you sink your teeth into this idea, here's the relationship between changes in the dollar and future changes in gold. In other words, this answers the question - if the dollar actually does fall, what happens to gold over the next year?
The results are in. Assuming we get a decline in the dollar of just 5% or more over the next year, we can expect gold to rally by anywhere from 10% to 50%. In fact, the bigger the fall in the dollar, the bigger the rally in gold. What are you waiting for? It's time to buy gold (NYSEARCA:GLD).
Disclosure: I am/we are long NUGT.
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.