After posting its first negative week in the last six, the gold price, at $989.38 per ounce, remains approximately $40 below its all-time high. The driver this coming week will be the movement of the U.S. dollar, which is currently oscillating as investors’ appetite for risk changes. Last week, weak housing and durable goods figures caused investors to retreat from riskier asset classes. The dollar rallied and stocks, commodities, and the gold price all declined as the week came to a close.
The big economic data point of the week comes on Friday when the Labor Department releases the September unemployment report. According to a Bloomberg survey, the consensus estimate is for a decline of 180,000 non-farm payroll jobs and a slight uptick in the unemployment rate to 9.8%. The debate rages on over when and at what pace the Federal Reserve should begin to move away from their current zero interest rate policy. A weak employment outlook is the chief rationale for a continued ultra-loose monetary policy. The current 9.7% unemployment rate would spike to nearly 17% if discouraged workers (have not actively sought employment in four weeks) and under-employed workers (part-time workers who desire full-time employment) were counted in the statistics.
Due to near-zero short rates, investors have pulled out of money market funds as they have been essentially forced out the risk spectrum into equities, commodities, and corporate and municipal bonds. The search for a decent return on capital has caused a furious equity market rally and a contraction in credit spreads to pre-Lehman collapse levels. The equity market, if current prices hold for the last three days of September, will finish up for the seventh consecutive month.
U.S. dollar depreciation has been a side effect of both the Federal Reserve slashing of short interest rates as well as the ballooning of the Fed’s balance sheet to over $2 trillion dollars. The dollar has become the new funding currency and the dollar carry trade has financed investments in higher-yielding and riskier assets, such as foreign currencies, equities, and commodities. Market participants have been eagerly analyzing every word out of Fed officials and policymakers to gauge when the unprecedented monetary policy initiatives will be unwound. Fed Governor Kevin Warsh penned an op-ed in the Wall Street Journal last week, in which he warned that the Fed may need to raise rates in a more aggressive fashion that market expectations. If Warsh’s views resonate with Wall Street, the asset classes that have benefited in recent months, including the gold price, will be at risk of at minimum their first real correction in six months.
Over the long-term, the gold price and gold mining equities, which are counter-cyclical, have displayed a negative correlation to the S&P 500. However, recently short-term correlations have risen. Larry Summers, former Secretary of the Treasury and current Chief Economic Advisor to President Obama, and Robert Barsky wrote an academic paper in 1998 titled Gibson’s Paradox and the Gold Standard. Their research led them to the conclusion that the price action in the gold price is driven by the reciprocal of the real rate of return from the global capital markets. Gold is a sterile asset that pays no rate of interest and investors’ penchant for holding gold is dependent on what alternative rate of return is available in other asset classes. A low-return environment in traditional asset classes such as equities and bonds will create increased demand for gold. The relatively small size of the gold bullion market and the gold equity market, combined with the magnitude of potential demand creates a situation wherein explosive price gains are a possibility. In summary, per Summers and Barsky’s research, the recent investment climate characterized by tepid returns in stocks and bonds strengthens the case for holding some exposure to the gold price and gold equities in spite of the risk associated with a short-term correction.
