Gold has lacked volatility for a long time. Since the summer of 2013 gold has largely remained in a tight price channel between $1,100 and $1,380. During that time it seemed like prices couldn't go much lower because the world's big three central banks were historically dovish.
Gold also couldn't get any traction to the upside because the Fed was the least dovish of the three and the dollar was strong on a relative basis. Something, however, may have changed over the last three months, which could mean that our long wait for volatility is ending.
Since November 2018, we've seen a significant shift in the market's attitude toward U.S. domestic economic expansion.
Deterioration in data, corporate earnings along with a persistently flat yield curve have caused some to predict that the next recession is not far away. I don't think the pessimists are correct but it's certainly worth a deeper dive into the recent drivers of the economic slowdown and the subsequent effect on assets like the U.S. dollar, interest rates and gold.
Number one on the list seems to be the ongoing trade discussions with China. As this situation persists the belief is that it will be a constantly growing headwind to growth. This along with the possibility of additional tariffs has caused major market concern.
Also on the list of market concerns is the Brexit situation. Both the pound and the euro have had significant moves lower over the last year as we have received a constant stream of conflicting news and uncertainties tied to the Brexit negotiations. The U.S. debt ceiling talks and a possible shutdown should be mentioned here as well, even though I think those factors are bit players in this drama but worth watching.
Gold Hates High Rates
What will be the cocktail of fundamental factors that could push gold above the $1,380-1,400 level and suggest a much higher move? Number one is that gold loves a dovish Fed. Gold hates high rates because it makes it more expensive to hold a zero-yield asset by comparison.
The Fed's recent pivot from hawkish to "data dependent " has been positive for gold to the tune of a 10 percent rally but it feels like that is not quite enough. If the Fed pivots toward dovish it will be good for gold, but there's a catch. If the Fed's change of heart is caused by problems in Asia or in Europe, the dollar could maintain its strength in a lower-rate environment because its value is primarily measured against the yen and the euro.
The best case for gold would be if the Fed moved toward easing solely because of a weakening U.S. economy. In this case the dollar would lose value and rates would move lower. Additionally, if the domestic weakness appears that it may persist and require long-term central bank intervention gold could swiftly shift to the "gotta have it" asset of 2019.
A Counterbalance to Gold
At this point in the discussion it may become conspicuous that I haven't written "inflation" even once. The reason is that I believe the Fed would move back towards tightening at the first sign of inflation and that should provide a counterbalance on the price of gold.
Finally, there is a scenario in which U.S. equity prices decline to a level that creates a broader panic. This situation could cause gold buying on a flight to quality trade and would probably evoke a reflexive Fed ease which would add fuel to the rally.
For me, the simplification to all of these moving parts is as follows: If the dollar declines based on lower interest rates in response to a domestic recession threat, gold could rally significantly.
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