While other commodities struggled to stay afloat, gold was having a red letter year. Opening up 2016 just shy of trading at $1,080 per ounce, gold rose to highs that nearly topped $1,380 by mid-summer – a gain of more than 27%.
Investors lost their appetite for risk, preferring a safer bet; while the U.S. dollar began to slip amidst mixed economic data and dovish Fed statements that seemed to indicate an interest rate hike was unlikely to happen for quite a while.
But gold has been on a steepening slide for a week crossing down below $1,300, before a precipitous drop to around $1,266 per ounce. Gold is still up 17% year-to-date, but the sudden drop in value has investors worried whether the trend will continue or if the decline is only temporary.
A Fed-Driven Market Is Bad for Business
Gold’s popularity is mainly driven by investors looking for a safe haven against risk or inflation. There’s some industrial use for the precious metal, but its primary purpose is to serve as a wealth protection tool. Of course there hasn’t been anything resembling high inflation for years now, but gold’s rise is based on the decline of the U.S. dollar and investors looking for a less risky asset class than stocks and bonds.
The Fed’s inconsistent views regarding the economy have led investors to discount anything Yellen says. Dovish or hawkish, investors are beginning to crave risk again – and that’s bad news for gold.
Improving data on the economy is the obvious trigger for gold’s decline in the past week. U.S. manufacturing data came back higher than estimates predicted earlier this week and reignited the possibility of an interest rate hike before the end of 2016.
The U.S. dollar has seen a resurgence lately as well, benefiting from higher investor confidence in the economy and the idea of higher interest rates sooner rather than later. But any major move in the markets won’t happen until after the election cycle is over. Investors are holding their breath, waiting to see which way votes will go and what that will mean for the markets.
While the economic data is pointing to a continuing bull market, gold’s role as a protective asset class may not be over just yet. Improving demand coming out of China is lifting all commodities right now and precious metals could see some improvement while caught in the rising tide.
Investors should note that the surge in commodities driven by Chinese demand is only temporary. Commodity production growth in industries like iron ore is flat, and the only thing driving values are Chinese policies intended to squeeze every last drop of production from its economy. Moving forward, investors should watch gold carefully with the expectation that it could fall even further if interest rates go up before the end of the year.