Gold managed to rebound slightly in 2016, rising 8% and making back a bit of the lost ground that it has suffered in previous years. A new U.S. president has entered the Oval Office this year. His policies, while embraced by Wall Street, are untested largely. Trump’s first few days in office and he has already signed a bunch of executive orders making good on some of his campaign promises. Suffice it to say geopolitical tensions are fraught at this point and this could be good news for gold. Month-to-date gold prices have increased 4%.
Bubble size represents market cap
FIGURE 1: PERFORMANCE OF GOLD MINERS
Description: Figure 1 highlights the performance of the gold mining industry for the month of January 2017 (x-axis) and the performance of the 11 months prior to January 2017.
At the same time, U.S. economic data is encouraging, stocks are at record levels, interest rates are up, and there is some belief that new economic policies will be good for corporate America, which makes gold prices more vulnerable. So, where do we go from here? Many are uncertain about the direction for gold prices in 2017. Predictions for where gold prices will go in 2017 vary wildly. As you can see below there are a couple of different camps among gold market analysts.
The Bullish Case for Gold:
Gold has always been a hedge against geopolitical uncertainty. There were more than enough reasons for investors to hedge against political and economic uncertainty in 2016 and protect their assets. The global perception of Trump has raised fears of changing global alliances and greater levels of conflict, and the rise of other populist leaders in various countries throughout the world suggests a growing trend toward nationalism. This could have implications for trade, which in turn could destabilize economies that rely on trade. Historically, such situations have been positive for gold.
To add, not everyone is convinced that a rise in interest rates will come without inflation. Gasoline prices have already risen from their lows last year, and despite the dollar’s steady rise these past few months, a greater emphasis on manufacturing in the U.S. could force companies to raise prices to offset higher labor costs. If inflation outpaces the Fed’s gradual rate hikes, gold could respond positively.
The Bearish Case for Gold:
The primary reasons to foresee some problems for the gold market have to do with macroeconomic conditions. The odds are good that we will see the U.S. Federal Reserve raise interest rates in 2017. However, inflation will not be the reason why the Fed will do so. The expectation is that the Fed will increase rates simply to bring the rates back to a normal level, while seeking to prevent inflation from rising above its 2% target. If the Fed is successful, that eliminates the inflation argument for owning gold.
At the same time, higher interest rates in the U.S. have typically made the U.S. dollar stronger. Since the price of gold is measured in dollars, a strong dollar would put downward pressure on the gold price. We’ve seen that correlation in recent months, as the post-election rally in stocks sent interest rates lower while boosting the dollar’s value against major foreign currencies like the Euro and Yen.
Expect a Bumpy Ride for Gold in 2017
Gold markets have rarely moved in a straight line, and that’s likely to be more the case than ever this year. With surprises likely on multiple fronts, investors should expect gold prices in 2017 to be more volatile than usual, creating opportunities for those who believe in its longer-term prospects.