How Trade And Central Bank Policy Are Driving Gold Volatility

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Includes: AAAU, AWTM, BAR, BBSA, BIL, CLTL, DFVL, DFVS, DGL, DGLD, DGP, DGZ, DLBL-OLD, DLBS, DTUL, DTUS, DTYL, DTYS, DZZ, EDV, EGF, FIBR, GBIL, GLD, GLDI, GLDM, GLDW, GLL, GOVT, GSY, HYDD, IAU, IAUF, IEF, IEI, ITE, IVOL, OPER, OUNZ, PHYS, PLW, PST, QGLDX, RINF, RISE, SCHO, SCHR, SGOL, SHV, SHY, SPTL, SPTS, TAPR, TBF, TBT, TBX, TLH, TLT, TMF, TMV, TTT, TUZ, TYBS, TYD, TYNS, TYO, UBG, UBT, UDN, UGL, UGLD, USDU, UST, USTB, UUP, VGIT, VGLT, VGSH, VUSTX, ZROZ
by: CME Group
Summary

In times of market volatility and economic contraction, gold becomes a safe haven investment as investors look for steadier returns and lower risk to their portfolios.

Gold, now up almost 18 percent year to date, has been supported near six-year highs by an escalating U.S.-China trade war and fears of a global slowdown which may lead to a recession in the United States.

The U.S. Federal Reserve has set itself on a likely interest rate easing cycle. The more money the Fed prints, or "creates", the higher the price of gold goes long term.

Many investors believe that changes in the price of gold can have an impact on the economy, but it's more typical to see gold prices reflect economic conditions rather than cause them.

Originally published on August 30, 2019

By Scott Bauer

At a Glance

  • China-U.S. Trade War, Hong Kong unrest and Fed policy have been tailwinds for the yellow metal.
  • 10-year yields below 1.5 percent and the dollar decline versus the yen are also bullish signs for gold.

Why does the price of gold fluctuate, and why has the precious metal seen so much volatility in recent months? During times of expansion and a robust economy, investors typically opt for riskier assets with the potential for higher returns.

In times of market volatility and economic contraction, gold becomes a safe haven investment as investors look for steadier returns and lower risk to their portfolios.

More Money, Higher Gold Price

Gold, now up almost 18 percent year to date, has been supported near six-year highs by an escalating U.S.-China trade war and fears of a global slowdown which may lead to a recession in the United States. The recent slide in emerging market assets and continued unrest in Hong Kong have added strong tailwinds to the shiny metal. And last but not least, the U.S. Federal Reserve has set itself on a likely interest rate easing cycle.

Since the Fed typically does not flip on policy on a short-term basis, we may just be in the beginning of a long-term easing path that will flood the financial system with dollars to help prevent a recession. Essentially, the more money the Fed prints, or "creates", the higher the price of gold goes long term.

Lower Bond Yields, Weaker Dollar

We have recently seen the 10-year Treasury yield tumble below 1.5 percent, stocks sell off and the dollar decline towards its 2019 lows versus the yen. Lower bond yields and a weaker dollar are both typically bullish for gold. Gold usually benefits during periods of ultra-low interest rates, as it offers investors a better alternative to bonds and savings accounts with little to no return.

And if the Fed continues to ease, the dollar will likely head lower. Other central banks like the European Central Bank and Bank of Japan are already at zero or negative benchmark rates, and the Fed has much more flexibility to lower the dollar relative to these other central banks.

Gold Reflects Economic Conditions

Many investors believe that changes in the price of gold can have an impact on the economy, but it's more typical to see gold prices reflect economic conditions rather than cause them. Let's take a look at many ways in which gold prices tend to respond to changes in the economy.

A lower dollar makes gold a more attractive investment in other currencies. A stronger dollar means that even if gold prices remain flat in dollar terms, gold becomes more expensive in other currencies whose value has declined versus the dollar.

When the economy is strong, assets other than gold tend to outperform. Stocks rise in value, which makes the opportunity cost of owning gold and other commodities less attractive, since they don't generate any income. But as the economy weakens, demand for stocks and other assets weakens, which drives money towards more stable investments such as cash and gold.

Middle East Tensions, Brexit, Hong Kong

Geopolitical instability has contributed to the surge in gold, and this doesn't seem to be ebbing anytime soon. Rising tensions in the Middle East, Brexit, and the aforementioned unrest in Hong Kong are all reasons why investors have flocked to safe haven assets like gold.

An investor who may want to hedge a portion of his portfolio against inflation, lower yields or any of the above can use a host of gold futures products, including full (GC -100 oz), E-mini (QO - 50 oz) or E-micro (MGC - 10 oz) contracts. Since gold prices respond quickly to political and economic events, these instruments provide market users with valuable risk management tools.

In fact, COMEX gold options reached several consecutive record open interest days at the end of August. Since open interest represents the number of contracts outstanding, it's a good indicator of just how much traders and investors are watching gold prices.

As long as Federal Reserve policy, the trade war and the U.S. dollar remain in their current cycles, that's a trend that could very well continue.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.