Commodities: Gold Price Lacking Fundamental Drivers

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08/04/2017 | 10:23 am
With gold advancing to a 6-week high, we consider briefly the current fundamental drivers behind precious metals, and therefore the probability of this becoming a sustained move.
With gold advancing to a 6-week high, we consider briefly the current fundamental drivers behind precious metals, and therefore the probability of this becoming a sustained move.

Precious metals are showing some buyers coming back, but we think this is mostly in combination with copper, zinc, and oil, all of which are economy-based consumables, and are at low cyclical prices due to absence of industry capital expenditures (capex). For gold, there is neither extreme inflation nor deflation to drive the price. The price gold in dollars has lifted only because of the dollar falling against major world currencies. The price of gold in euros, for example, is near an 18-month low, as shown in the chart below.

The break-out in gold that so many analysts are calling for is only going to happen should the dollar have a major cycle break-down (after many months of weakness already – the dollar index is down almost 11% year-to-date). A prolonged bear market in the dollar index (which measures the dollar’s value versus the currencies of major trading partners) that would bring inflation concerns to the U.S. due to the nation’s reliance on imports. For the time being, we prefer the economy-based consumable commodities for now.

The global economy is in good shape, but much more capex is required to sustain its growth. Futures trading does not deliver the commodity products which the global economy needs. Computer algorithms can direct the prices of consumables only for so long. Basic resources like oil, copper, and zinc cannot be manufactured out of air … at some point economic supply-demand must be factored into price. If not, we are all facing a future of major recessions terminating in depression.

While there are definite reasons to invest in Gold, particularly as a hedge against central bank policy errours or as a collectible, it is not a consumable metal per se. During normal times — and despite all the naysayers, these are normal times in economic cycles — central bankers can fairly easily control the price of gold, as they have over the past four plus years.

As we see things, gold (which is priced in dollar) is working through a long cycle bottom that will not break to the upside unless (and until) the dollar crashes on account of inflation. Over many hundreds of years, inflation typically only happens during times of world wars when basic materials are wasted on a massive scale — blown up as is the case — and we currently only have the U.S. position against the North Korean threat to be concerned about in that regard.

The dollar and other major currencies could also drop against the price of gold in a period of extreme deflation, which is possible in these times of massive economic change due to technologies replacing labor. That is a global problem and we see the central banks trying to fight back with ever growing balance sheets comprised of too many intangibles. The problem there, with respect to the impact on gold, is that trade-weighted currencies are remaining fairly well connected, thereby giving only a small boost to gold priced against a basket of currencies.

So, for now, before we conclude that a break-out in gold is happening, let’s watch to see if the short-term cyclical price rise in gold continues through a period of  rally in the dollar. Instead of following squiggly lines on a chart, gold investors should read the reports of the world’s major central bankers with respect to possible fact-based concerns of inflation or deflation.
Bill Cara
© 2017
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