IAU: The Fed Just Provided Confirmation For Gold Bulls

Summary

• The IAU ETF is up by about 9.89% over the past few months amid an increasingly dovish Fed.
• Fed chairman Powell has satisfied markets' need for more accommodative monetary policy guidance.
• Weakening trends in the housing sector could undermine Fed's willingness to turn hawkish for the foreseeable future.

Following mostly sideways performance for about a month, the shares Gold Trust (NYSEARCA:IAU) ETF is up 11.09% since Dec. 24, 2018. The performance of gold is strongly inversely correlated to movements in the US dollar, because the metal is a dollar-denominated commodity. The stronger the USD becomes, the more expensive it becomes to buy gold. The dollar has been softening lately, which in turn benefits demand for gold and consequently the IAU ETF. The chart below demonstrates the inverse correlation between the US Dollar Index (green line) and IAU ETF (blue line). The latest statements from the Fed could support gold prices and the ETF higher.

Source: Yahoo Finance

Prospectus Review:

The IAU ETF tracks the price of gold by using the ‘LBMA Gold Price’ as its underlying benchmark. The fund offers this exposure by holding physical gold in its portfolio. It seeks to offer a more convenient mechanism to invest in gold, as an alternative to having to transport and store physical gold.

Risk note from prospectus:

Because the Trust does not have any income, it needs to sell gold to cover the Sponsor’s Fee and expenses not assumed by the Sponsor. The Trust may also be subject to other liabilities (for example, as a result of litigation) that have also not been assumed by the Sponsor. The only source of funds to cover those liabilities will be sales of gold held by the Trust. Even if there are no expenses other than those assumed by the Sponsor, and there are no other liabilities of the Trust, the Trustee will still need to sell gold to pay the Sponsor’s Fee. The result of these sales is a decrease in the amount of gold represented by each Share.

The reason I have chosen this ETF is because it offers a convenient investment vehicle through which exposure to physical gold can be achieved. Moreover, out off all ETFs that offer exposure to physical gold, this ETF has one of the highest Assets Under Management (AUM) according to ETFdb.com, currently standing at $12.4 billion. I consider AUM as a good indicator for how successful the fund has been in implementing its strategy to deliver on its objectives for investors. The higher its AUM, the more investors have allocated their capital towards the fund due to effective management. Furthermore, it has the highest average trading volume, presently at 14.5 million. Hence this means that the ETF has a very healthy level of liquidity. This is a good indicator for how easily investors can buy and sell shares in the ETF. Therefore, the higher the trading volume, the lower the liquidity risks.

The Fed delivers on markets’ wishes

On Jan. 30, 2019, Fed chairman Powell issued some very dovish statements. They decided to place rate hikes ‘on hold’ and convinced markets that they will be ‘patient’ with future tightening. Powell cited “cross-currents” such as the US government shutdown, Brexit and economic slowdown in China as reasons to remain cautious. His pause in rate hikes sent the US Dollar plummeting, and consequently allowed the inversely correlated gold prices/ IAU ETF to rally higher. Thus one of the main headwinds for gold miners, namely a ‘hawkish Fed’ has essentially been eliminated for the near-term. Thus I believe this development will continue to provide support for the ETF for the foreseeable future. Though investors should beware that if issues such as the US government shutdown and Brexit are permanently resolved, then it could potentially trigger some hawkish sentiment from the Fed. Nevertheless, persistently weakening economic data domestically could inhibit the Fed from turning hawkish again this year, which will continue to provide support to gold prices and IAU ETF.

Mixed housing data

One of the main sectors to be hurt by a hawkish Fed from last year is the housing sector, which as shown notable weakness lately. While new home sales data on Jan. 31, 2019 came in better than expected, coming in at 657k versus 560k estimate, it comes after a significant decline over several months, as exhibited by the chart below.

Source: Yahoo Finance

Moreover, the latest pending home sales index data had been extremely disappointing, coming at -2.2%, widely missing the 0.3% consensus estimate. This also reflects a worsening from last month’s -0.9% reading. Hence, these concerning trends over the past few months in the housing sector certainty can not be avoided, and is likely increasingly encourage the Fed to remain dovish in the near future to avoid aggravating the circumstances. Therefore, a dovish Fed will continue weakening the USD, and thereby help the inversely correlated gold prices and IAU ETF move higher.

Strategy

Given the Fed’s extremely dovish statements following its latest monetary policy meeting, and the persistent claim to remain ‘patient’ going forward, gold prices and the IAU ETF could continue experiencing an upward rally. Recent weak economic trends are also supportive of a dovish Fed for the foreseeable future. Therefore, I would recommend ‘long’ positions in the IAU ETF. Though investors should beware of any positive developments from the “cross-currents” acknowledged by Powell, or any stronger than anticipated economic data, as this could raise chances of a more hawkish Fed going forward, which would hurt gold and IAU ETF performance. Nevertheless, as long as the predominant trend remains that of a ‘weakening’ economy, then the Fed will inevitably have to remain dovish. Hence, 'dips' in gold prices and the IAU ETF as a result of positive economic data releases could offer buying opportunities, as a predominantly dovish Fed will continue to provide support for the IAU ETF.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in IAU over the next 72 hours. 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.