After an apathetic performance in 2015, gold is off to a spectacular start this year. It’s up nearly 17% year-to-date despite the U.S. dollar stubbornly remaining strong. Goldbugs everywhere are celebrating gold’s sudden revival as it hit a one-year high of $1,260, and it’s still looking strong. In fact, all the evidence points to the rally building up momentum.
But Wait, There's More
Not only has gold done well so far this year but most investors believe it’s going to continue going up. Traders are attributing gold’s rise to early demand from Chinese buyers, and gold mining stocks are the big winners for this scenario. The Market Vectors Gold Miners ETF (GDX) is up over 3.5% year-to-date – a significant achievement considering that the broader indexes are down more than 6% for the year.
Perhaps a more compelling case for gold’s future gain is the fact that hedge fund managers have raised their bullish bets on the U.S. COMEX to a 12-month high. Mining stocks are investors’ best bet right now with the environment of low energy costs meaning that the cost of extracting the precious metal is lower than ever.
Freeport-McMoRan (FCX) is up over 32% year-to-date – the stock jumped 15% overnight just this week. BofA/Merrill upgraded the stock this week as well. Barrick Gold Corporation (ABX) may be the biggest gold mining stock winner this year – up 84%. It’s evidence that gold mining stocks are outperforming the rise in gold as investors begin pouring into anything related to the precious metal.
What's Keeping Gold Afloat?
So what’s making gold suddenly so shiny? Chinese demand helps, as does the struggling stock market. But there’s a deeper cause that’s propelling gold higher. Gold is a safe-haven asset because it holds its value irrespective of fluctuating currencies or equity fluctuations. Gold’s value is generally tied to inflation – a deflationary environment equals high gold values.
But inflation spiked in January to 1.4%, prompting many analysts to think that Janet Yellen’s previous deflationary concerns were no longer valid, and in fact another rate hike could be coming later this year. The reason gold will continue to rise is because yields aren’t rising at the same rate. The 10-year Treasury yield has dropped from 2.27% to 1.85% – a total drop of more than 18% year-to-date.
The drop in yields along with the rise in inflation means that the real interest rate has fallen to just 0.45%. Compare that to only a few months ago when inflation was less than 1%, while yields topped 2%. When real rates drop, that’s good news for gold. With inflation rising, gold should continue to enjoy further gains.
The Bottom Line
Gold looks to be caught up in a long-term bull market that’s only just beginning. Whether inflation is here to stay remains to be seen, but it will be telling for gold’s future either way. As long as energy prices remain low, gold mining stocks should have higher margins and produce higher earnings as a result as well. It’s the perfect storm brewing in gold that investors are riding to higher profits.