As it becomes increasingly likely that the US Federal reserve will raise rates as early as December (and yes, you might be reading this after the December meeting, but it still applies), gold is under pressure. The market logic is that, with a rate increase indicating that the US economy is getting stronger, the US dollar, in turn, grows stronger relative to other major currencies.
Since investors perceive the US economy as both stable and strong, they usually have their wealth stored in dollars, hence, the reason why the dollars is a reserve currency. However, once there’s panic around the US economy, which invariably threatens the value of the dollar, investors would understandably start looking for ways to secure their wealth, which would involve storing their wealth in anything other than the US dollar. Here’s where gold comes in to play, since it’s viewed as a preserver of wealth.
Since the laws of demand and supply must play out, at any sounds of a crack in the US economy, the demand for gold starts to trend north, and hence, the price of gold. Flipping the coin, once the US economy starts emitting positive vibes, the US dollar becomes a more attractive preserver of wealth and hence, diminishing the demand for gold.
However, this is only an explanation as to why the US dollar and gold are inversely correlated. And this is what governs the decision of most gold investors. However, that’s not the entire story. Here’re a couple of additional facts you should know.
Gold Should Be Treated Like an Investment Not a Speculative Instrument
It’s true that gold doesn’t perform remarkably when the US economy is strong, or at least seems strong. So when you look at the performance of gold in patches, it looks very volatile. However, over a longer timeframe gold performs excellently. For instance, even though gold has seen an all-time high over the past decade and has since dropped by over $660 from the all-time high to the current $1170 region it is, it has outperformed the S&P 500.
It’s noteworthy that the S&P 500 has been trending north consistently since 2011, reaching an all-time high earlier in 2016. Since the turn of the millennium, gold has returned over 304% vs. S&P 500’s 55.27% return over the same period.
It’s easy to say, but the global financial crisis happened during the time. So yes, that should be expected. That’s correct. However, during the period of economic expansion between 2000 and 2007, gold outperformed the S&P 500 – 168.9% and 1.78% returns respectively.
If we went deeper to see the performance of gold in patches during that period, you’d find that it responded to the US economy most of the time. Yet, it’s outperformed the most important equities to the US economy.
One thing that you won’t be told is that gold, like any other tradable asset class will, won’t react in a uniform manner to reports on the strength of the US economy. Sometimes, it’d respond minimally. At other times, the reaction will be high. That’s because there are other factors involved, of whose combined force will also matter (more on this below). So you may only be able to see the real picture over the long-term, as we’ve just seen.
So yes, gold might not be on the up once the Fed raises benchmark rates. However, it doesn’t make much sense to sell off the golden portion of your portfolio on account of a rate hike.
Global Uncertainties Still Lurk
As stated above, other factors affect the price of gold other than the strength of the US economy. One of them is the strength and decisions of economies elsewhere. For instance, the Japanese government said it’s seeing economic weakness around the globe in a November study. Investors around the globe will want to preserve their wealth as well. And gold is definitely an option.
This will influence the demand and supply dynamics of gold, as it will invariably work against the strong US economic force in regards to gold pricing. In fact, this makes it even less smart to sell gold right now. If I were trading either on a binary options trading platform or any other type of trading, I’d actually find it difficult betting against gold right now.