For the past several weeks, we’ve focused on the stock markets due to the earnings season, but in the meantime, the price of gold had a massive performance. It already breached above the September 2011 high, before starting a corrective move lower a few days ago. Fueled by a weakening US dollar, investors had been piling on gold, but with price near all-time highs, is it overextended?
Massive deficits and money printing – good for gold?
The combination of fiscal and monetary support had been a major tailwind for the gold price. In March, funding issues led to a rising US dollar, which was hurting gold, but as the Federal Reserve and the US government stepped in aggressively, they managed to solve the issues in the short-term. The DXY (dollar index) topped around 103 and now lies around 93, close to the August 2020 lows.
Since the COVID-19 pandemic had generated the most severe economic crisis since WWII, market participants are betting the government support will continue for years in a row. With debt-to-GDP levels are record levels, the only way forward is increased spending, capping the yield curve below the rate of inflation, and supporting asset prices via financial engineering.
Short-term risks for gold
We don’t know yet how things could play out, but gold looks like a good investment given all these implications. However, some downside risks are still present and should not be ignored. Rising US dollar is one of the key headwinds, as well as solvency (not liquidity) issues showing up starting in the fall. If that would be the case, central banks won’t be able to step in with liquidity.
A wave of bankruptcies can trigger a new wave of selling and even gold can underperform in a dollar-rising environment coupled with an increased search for liquidity.
In 2008, during the GFC, gold had been consolidating lower and only after the economic activity bottomed, it started a larger bull run. A similar situation could unfold over the next few years. Given it managed to break above the 2011 highs, the technical picture for gold had improved and even though a corrective move might start, the long-term prospects are very encouraging.
How far can gold go in the next 3 or 5 years? The magnitude of the move is hard to anticipate, given gold is a commodity hard to price accurately. What’s important is that it continues to be a popular investment and that provides enough confidence for investors and CFD traders.