Gold is universally recognized as a safe-haven investment, a go-to asset class when others look uncertain. Following the 2008 financial crisis, for instance, the metal's price surged, eventually topping out at $1,900 per ounce in August 2011.
But this week has been a particularly rocky one for the metal, even with Greece and Puerto Rico's debt dilemmas, not to mention the recent Shanghai stock market decline, fresh in investors' minds. Gold has traded down for 10 straight sessions to end the week at $1,099 per ounce, its lowest point in more than five years. Commodities in general have dropped to a 13-year low.
Gold stocks, as expressed by the XAU, have also tumbled.
The selloff was given a huge push last Friday when China, for the first time in six years, revealed the amount of gold its central bank holds. Although the number jumped nearly 60 percent since 2009 to 1,658 tonnes, markets were underwhelmed, as they had expected to see double the amount.
Then in the early hours on Monday, gold experienced a "mini flash-crash" after five tonnes appeared on the Asian market. Initially this might not sound like a lot, but five tonnes equates to 176,370 ounces, or about $2.7 billion. It also represents about a fifth of a normal day's trading volume. Suffice it to say, price discovery was effectively disrupted. In a matter of seconds, gold fell 4 percent before bouncing back somewhat.
Reflecting on the trading session, widely-respected market analyst Keith Fitz-Gerald noted: "Far from being a one-day crash, this could represent one of the best gold-buying opportunities of the year."
The last time the metal descended this quickly was 18 months ago, on January 6, 2014, when someone brought a massive gold sell order on the market before retracting it in a high-frequency trading tactic called "quote stuffing." Last month I shared with you that we now know who might have been responsible for the action—and many others that preceded it—and pointed out that the accused party's penalty of $200,000 was grossly inadequate. On Monday I told Daniela Cambone during this week's Gold Game Film that such downward price manipulation seems to result in little more than a slap on the wrist. But if manipulation is done on the upside, traders could get into serious trouble.
Besides apparent price manipulation, other factors are affecting gold's behavior right now, three in particular.
1. Strong U.S. Dollar
Like crude oil, gold around the world is priced in U.S. dollars. This means that when the greenback gains in strength, the yellow metal becomes more expensive for overseas buyers. With the U.S. economy on the mend after the recession, the dollar index remains steady at a 12-year high.
It's important to recognize, though, that gold is still strong in other world currencies, including the Canadian dollar. As such, our precious metals funds have hedged Canadian dollar exposure for Canadian gold stocks, which has benefited our overall performance.
2. Interest Rates on the Rise?
Federal Reserve Chair Janet Yellen continues to hint that interest rates might be hiked sometime this year, perhaps even as early as September. When rates move higher, non-yielding assets such as gold often take a hit.
As you can see, the 10-year Treasury bond yield and gold have an inverse relationship. When the yield starts to rise, investors might find bonds a more attractive asset class.
3. Slowing Manufacturing Activity
Earlier this month I wrote about the downtrend in manufacturing activity across the globe. As many loyal readers are well aware, we closely monitor the global purchasing manager's index (PMI) because, as our research has shown, when the one-month reading has fallen below the three-month moving average, select commodity prices have receded six months later.
China is the 800-pound commodity gorilla, and its own PMI has remained below the important 50 threshold for the last three months, indicating contraction. The preliminary flash PMI, released today, reveals that manufacturing has dipped to 48.2, a 15-month low. For gold and other commodities to recover, it's crucial that China jumpstart its economy.
In the meantime, we're encouraged by news that the slump in prices has accelerated retail demand in both China and India, which, when combined, account for half of the world's gold consumption.
Battening Down the Hatches
They say that a smooth sea never made a skillful sailor. No one embodies this more than Ralph Aldis, portfolio manager of our precious metals funds. He and our talented team of analysts are doing a commendable job weathering this storm. We're invested in strong, reliable companies, and when commodities eventually turn around, we should be in a good position to catch the wind.
We look forward to the second half of the year, when gold prices have historically seen a bump in anticipation of Diwali, which falls on November 11 this year, and the Chinese New Year. As you can see, average monthly gold performance has ramped up starting in September.
"Gold is down 15 to 25 percent below production levels," Ralph says. "That might cause some companies to halt production."
And, in so doing, help prices find firmer footing.
After my San Francisco experience it only seems fitting that I traveled to Colorado, one of the first states to legalize cannabis for recreational use. It was only a coincidence that Julia Guth chose to retreat to the state's beautiful mountains for the Oxford Club's educational seminar. It was a privilege to present to two assemblies of curious investors like yourself. I enjoy meeting many of you when I'm on the road.
Domestic Equity Market
Strengths
- Consumer discretionary was the best performing sector in the S&P 500 Index this week as investors moved out of areas with a large degree of foreign and/or commodity exposure. The S&P 500 Consumer Discretionary Sector Index fell 0.46 percent this week.
- Existing home sales in the U.S. climbed to the highest rate since February 2007. The housing market has been gaining strength over the last few months.
- Initial jobless claims fell to the lowest level in over 40 years, highlighting the tightening labor market in the U.S.
Weaknesses
- Materials got hammered this week as precious metals stocks declined over concerns of a September rate hike, while base metals stocks fell on concerns over a slowdown in the Chinese economy. The S&P 500 Materials Sector Index fell 5.47 percent this week.
- Energy slumped this week as crude oil prices continue to fall, testing the lows seen earlier this year. The S&P 500 Energy Sector Index fell 4.07 percent this week.
- Industrials underperformed given the lack of faith in Chinese growth as well as a depressed energy market. The S&P 500 Industrials Sector Index fell 3.81 percent this week.
Opportunities
- The Markit U.S. manufacturing purchasing managers' index (PMI) remains well above the 50 mark, with the most preliminary reading for June coming in at 53.8.
- The Conference Board U.S. Leading Index, comprised of economic variables that tend to move before changes in the overall economy, rose by 0.6 percent from the prior month, exceeding analysts' estimates.
- After contracting in the first quarter, the United States economy is expected to have grown by 2.6 percent in the second quarter, according to a Bloomberg survey of economists.
Threats
- Inflationary pressures should start becoming more prevalent in the economy as the labor market continues to tighten and wages rise. If there is a noticeable positive shift in inflation it would only strengthen the Federal Reserve's decision to raise rates in September, which could cause equities to retreat.
- Commodities are in trouble. The Bloomberg Commodities Index reached its lowest point since 2002, surpassing the lows seen during the financial crisis. With no trend shift in sight, commodity-sensitive plays could remain vulnerable in the near future.
- The Conference Board Consumer Confidence Index is expected to decline next week, which could weigh on retailers as well as other discretionary plays.
