Three months ago, I wrote a “gold update” in the midst of a powerful upswing in gold prices. At the time, gold, silver, and gold mining companies’ stocks had powerfully outperformed the S&P 500 stock index for about 3 weeks. I expressed that government fiscal and monetary policies were unsustainable, and opined that gold prices would likely rise for “many years” – with the only question being whether the recent “upswing” was already the beginning of a longer trend. Then I wrote this:
“More likely, a major uptrend may not begin for months or even years.”
Well, I was right… at least so far. No “major uptrend” in precious metals has yet begun. Far from it! But I didn’t necessarily expect what happened next, either.
In the 3rd quarter (July – September), gold lost about -7.5% of its value, silver declined by about -18%, and precious metals mining companies’ stocks gave up more than -18.8%. All this occurred during a quarter in which the S&P 500 stock index was basically flat, actually gaining about +1.1% during the 3-month period (until it gave up about -1.3% on October 1st).
The “other half” of my forecast, of course, remains to be seen. Many experts agree with me that today’s markets are unsustainable, and that gold prices will rise for many years once the uptrend begins. In the meantime, while gold is not performing well as an investment, we can look to other sources of potential returns (as shown in my portfolios). We can always get more aggressive with gold-related investments once performance begins to improve.
Why the pummeling?
The price of gold often moves inversely to changes in the value of the U.S. dollar. When the dollar weakens, gold often becomes more valuable.
In fact, many people invest in gold & silver precisely because they’re losing confidence in the dollar. They reason (correctly) that if the dollar weakens, each ounce of gold will be worth more & more dollars. So in anticipation of weaker dollars, they decide they’d rather own gold instead.
Conversely, though, when the dollar strengthens, each ounce of gold becomes worth less & less (relatively, when paid for using dollars). In other words, gold prices decline. And that’s precisely what happened in the 3rd quarter.
In September, the U.S. Dollar Index rose more than in any month since the 1990s, gaining more than +8%against the euro and the yen, for example. That’s a very large move for a single month!
What caused the dollar to rally? Is the U.S. economy really gaining that much solid ground? Not necessarily. Many experts refer to the U.S. as the “least rotten apple” in the basket. Instead, a combination of factors have probably played into the dollar’s recent spike (and therefore, to commodities’ recent decline).
First, the U.S. Federal Reserve is talking about raising interest rates in 2015, while many other nations are still talking about either lowering rates or ramping up monetary policies that have a similar effect (like “Quantitative Easing,” a.k.a., “QE” or “bond buying”). This talk of higher interest rates in the U.S. theoretically causes many investors to shift assets into U.S. dollars, thus leading to dollar strengthening.
Another major factor is the unrest in Ukraine, along with the corresponding sanctions the West is imposing upon Russia (which you barely ever hear about anymore due to ebola and the U.S. bombing of ISIS, but which is still on ongoing issue). The sanctions have contributed to euro weakness, and thus to dollar strength (…and thus to falling gold prices).
If this all makes your head spin, don’t despair. Trying to understand the interrelationships between currencies, commodities, and interest rates is even more complex than trying to understand the stock market!
Bottom line, you can often understand big price swings like what happened in September by simply “following the money.” Investors are simply “voting” with their pocketbooks, as they always do.
Certain assets (like “gold & oil” in this case) have recently fallen somewhat “out of favor” with many investors, and other assets have been attracting investors’ money. Right now, investors are chasing investments that benefit from a strengthening dollar and the possibility that U.S. interest rates will rise in 2015. Gold isn’t on the list of strong-dollar or rising-rate “plays.”
However, we should all keep in mind no one knows how long this dollar “trend” will continue. The strengthening dollar and rising interest rates may or may not last very long – just like gold’s big “uptrend” in June lasted only a little longer than 1 month! I wrote in early June about several reasons interest rates may NOT increase anytime soon, for example (and indeed, they haven’t… even though many people thought they would!). In fact, rates are lower now than 1 year ago… and falling! As of the market close on Oct. 1st, 10-year U.S. Treasury bond rates are within an eyelash of their lowest point in the last 15 months!
I don’t believe “rising interest rates” are – or will be – a reason for the dollar to continue to rally (or for gold prices to fall). Right now, investors seem convinced the dollar’s rally will continue for the foreseeable future. It may; but more likely, the dollar will continue to fluctuate when compared to foreign currencies, as well as when compared to gold. I, for one, will probably view any large declines in gold, silver, oil, gas, and the companies that produce those commodities as an opportunity to “buy low.” Note, I’m notready to pull the trigger on that just yet. Stay tuned.
What to do!
Full disclosure: I included a handful of investments related to gold, silver, and gold miners in my (inaugural) September portfolios (hoping to help you at least “buy low-er” than you could’ve a couple years ago). I also included some oil-related investments, only to see oil itself lose about -4.5% in September. Fortunately, I followed my own core beliefs to not get too carried away with my level of aggressiveness. First, I made sure my “gold & oil” investments represented a very small portion of the portfolios. Second, I also stopped short of investing those few dollars very aggressively. As a result, the poor performance of the modest “gold & oil” investments in my portfolios were mostly offset by better performance on other investments. Overall, my portfolios barely dropped in value at all during September, which was also a slightly down month for stocks in general.
My October portfolios recommend selling a couple of the “gold & oil”-related investments that have looked weakest over the last 30 days, while holding on to others. If prices continue to weaken, I’ll watch for opportunities to buy more shares of the stronger positions (hopefully after I see some sign(s) that the trend has turned positive again). On the other hand, if the investments turn around sooner rather than later, we’ll be glad you held onto them.
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