If the first couple of trading weeks in 2016 have taught investors anything, it’s that the global economy is in a much more tenuous position than originally thought. As uncertainty builds and oil continues to plummet, investors are fleeing from stocks into safe haven assets. But unlike past periods of high volatility, gold isn’t the asset to which they’re flocking.
Interestingly, the U.S. dollar has been the go-to refuge for worried investors. Part of the appeal is the Fed environment of raising rates for at least the next 12 months, although it’s likely to go on longer. The dollar, and the U.S. economy, is still seen as one of the most stable and reliable investments in the world. The collapse of China has only helped to boost the dollar’s value, while lowered demand for commodities is taking a toll on gold.
The Real Value of Gold
When investors enter uncertain economic times, they tend to flock towards assets that hold their value and weather the ups and downs of global equity markets. Traditionally, that’s been commodities – gold primary among them.
In the past year, however, gold has fallen from around $1,300 per ounce to less than $1,100 with no signal that the drop will end any time soon. Oil’s collapse seemed to temporarily boost gold’s appeal, but the short-lived rally was quickly overshadowed by other global macroeconomic concerns, such as China’s growth slowing even faster than anticipated.
The news is prompting investors to seek riskier assets in order to generate returns, eschewing gold with its offer of safety but low returns. But risk and physical demand for gold isn’t the main driver behind its low value right now.
For gold to fully realize its potential as a safe haven asset, there not only needs to be increased volatility in trading and global economic uncertainty, but there must also exist rising inflation that threatens to dilute the value of currency.
Right now, the yield on the 10-year Treasury is at about 2%, while inflation as registered by the CPI stands at 0.50%. That makes the real rate of return 1.5% – a positive figure that makes assets like bonds more valuable than commodities.
In order for gold to take over as the primary asset protection investment, inflation would need to top 2% in order to generate a negative real rate of return. If that were to happen, then we would see gold become a more valuable commodity as investors seek the protection of an asset that holds its value in the face of a declining currency.
The Bottom Line
The U.S. dollar and gold are two sides of the same coin. If one is strong, the other is weak. Until we see a pullback in the dollar, gold will likely continue to struggle. Falling oil prices also means that gold will stay unpopular as low energy prices tend to go hand in hand with low growth expectations – a poor environment for inflation to take root. Even if the global economy falls into a bear market, gold won’t be the key protection asset this time. The dollar looks to remain strong, especially with oil struggling. Once oil recovers, however, it could be the first sign of a recovery in gold values, too.