Why a Continued Rise in Gold Prices May Still Pan Out
In the first seven months of the year, gold prices regained some luster lost after a multi-year slump, buoyed by new financial risks and geopolitical developments. While Donald Trump’s surprise US presidential victory contributed to a more recent setback for gold prices, Steve Land, portfolio manager, Franklin Gold and Precious Metals Fund, believes a potential increase in US inflation and a drop in supply may help gold shine anew into 2017. Here, he discusses the challenges—and opportunities—gold-mining companies may potentially face in the year to come.
After a strong start to 2016, which saw the gold spot price rise from $1,060 per ounce at the start of the year1 to a high of $1,366 per ounce in July,2 prices lost some of their luster, as price-sensitive Chinese and Indian investors scaled back their gold purchases and investors settled down following the United Kingdom’s June vote to leave the European Union (Brexit), which had been a strong catalyst for the second quarter’s spike in demand. Gold-price volatility also increased leading into the US presidential election in early November. After it became apparent Donald Trump pulled off a surprise win, gold spiked up more than $60 per ounce in international trading during the night of the US election, but gave back the entire move as US markets opened. After the election, gold sold off as investors rotated to sectors that were viewed to be greater direct beneficiaries of a Republican-controlled House and Senate under President-elect Trump.
The price of gold currently sits at around $1,184 an ounce,3 or just over 11% higher than where it started the year. In early January, many investors began pouring their money into assets that are traditionally perceived as “safe havens,” which includes gold. Gold tends to attract investor attention as a store of value when markets are in turmoil because it typically has a low correlation with other asset classes and a long history as a financial instrument.
Gold prices also have been buoyed this year by historically low interest rates in many parts of the world. Low interest rates reduce the opportunity cost of holding physical gold. Although gold does not pay a yield and often has costs associated with storage, in a negative-rate world, more investors have turned to gold as an alternative to government bonds. Gold offers reasonable liquidity while not being tied to any one region, financial system or government.
Next year, elections around the world also could influence the price of gold, as was evidenced by the short-lived spike that occurred after initial results indicated Donald Trump had won the US presidential race. One of the key drivers for gold is uncertainty. While all elections bring change, given the US results this year and subsequent market reaction, upcoming elections in Europe and elsewhere seem to have the potential for more upheaval than most.
A further increase in US inflation also could boost gold prices, as some consider gold an inflationary hedge. This year, prices have responded to anticipation surrounding potential US monetary policy actions, selling off when the Federal Reserve (Fed) seemed to be moving in advance of inflation and rising when the Fed appeared to be willing to be behind the inflation curve. I should mention that gold prices are very difficult to predict, and their correlation with interest rates is not clear. The greatest short-term price swings have typically resulted from events the market wasn’t fully expecting, such as the United Kingdom’s Brexit vote in June.