What You Need to Know About Trading Gold

The English expression: May you live in interesting times is actually a derivation of the old Chinese proverb which was purportedly a curse. Nonetheless, we find ourselves at one such juncture today: Equities markets are enduring massive turbulence and investors are seeking safe-haven alternatives for their financial portfolios. Throughout modern history, gold has remained the safe-haven asset of choice. The recent Brexit referendum has highlighted the importance of gold bullion as the go-to investment, or store of value, while financial markets endure a category 5 storm.

Gold Performance Blows Away the Competition

If we look at the performance of gold over time, it paints a positive picture for a defensive approach to investing. For example, over the past 1 year, gold has appreciated by 18.02% or $207.70 per ounce. If we examine the performance of gold for 2016, we see a much improved performance of 22.79% or $252.40 per ounce. Over the past 30 days however, gold has appreciated by 9.30% or $115.70 per ounce. There can be no denying that gold is driven by exogenous factors more so then endogenous factors. The state of the global economy is the most important determinant of people’s demand for gold.

As we project ahead, talking heads and financial analysts are confident that gold will soon breach the critical $1,400 per ounce level and move quickly towards the $1,500 per ounce level. Bullish bets on gold bullion are pervasive. Sentiment is being driven by the uncertainty related to the Brexit referendum and the implications thereof. Now that Britain has officially voted 51.9% – 48.1% in favour of leaving the European Union, a can of worms has been opened up. The extreme volatility in currency markets has been matched in equal measure by the volatility in equities markets. To say that a risk-off approach has been adopted is an understatement. Trillions of dollars of value have been erased from stock markets and traders’ portfolios are emaciated.

Financial Giants Hedging their Bets on Gold

Bank of America Merrill Lynch is one such financial powerhouse that is going long on gold bullion. The US bank and its global research team of analysts believe that gold will increase by as much as 10% between July 2016 and December 2017. Gold is presently trading around $1355 per ounce and according to Bank of America, it will likely breach the $1,500 per ounce level within 18 months. If we extrapolate over time, it is clear that all manner of geopolitical crises have been driving investors towards safe-haven assets. We see this in things like government bonds with high prices and low yields (many in negative territory), a rush to gold bullion and silver, and other fixed-interest securities. Investors are simply averse to the wild fluctuations in prices that equities markets are offering.

The year began in an inauspicious manner with massive declines in major technology companies like Apple Inc. (Nasdaq: AAPL), Alphabet Inc., (Nasdaq: GOOG) and Microsoft Inc. (Nasdaq: MSFT). This was brought upon by a major sell off in the Shanghai Composite index and the Shenzhen Composite index in China. Recall that the Chinese economy recorded GDP growth of 6.5% for the final quarter of 2016, confirming suspicions that the world’s second-largest economy was indeed slowing down. The cataclysmic collapse in commodities prices (iron ore, steel, copper, crude oil) was brought on by a combination of weak Chinese demand and excess supply. Combined, this assault on equities markets resulted in a major sell-off. Commodities have been reporting sharp losses across the board, but gold has retained its luster.

Gold is a Safe-Haven Investment

Gold bullion is not an interest-bearing asset. This means that the precious metal does not return any profits as a result of investments in it. What gold does is work in an inverse relationship to the strength of the US dollar and the uncertainty in global markets. When equities markets are flourishing, gold typically moves in the opposite direction. When the USD is strong, the price of gold in dollars is higher (because it is a dollar-denominated asset) and demand for the precious metal decreases among foreign buyers. When the USD is weak, gold becomes relatively cheaper to foreign buyers and demand for the metal increases. We have an interesting set of circumstances developing now with the Fed. The Federal Reserve Bank has decided to hold off on hiking interest rates. What does this mean for gold? Simply put, it is a good sign for gold because the dollar will not appreciate relative to other currencies (ceteris paribus). When the Fed hikes rates, the USD becomes relatively more valuable and more foreign currency is required to purchase an equivalent ounce of gold.

We are now seeing some interesting central bank policy shaping up. The Bank of England (BOE) announced that it would be adopting quantitative easing measures as early as July 2016 to prop up the GBP and to stabilise the UK economy. This may not come to pass until later in the summer, but the intent is there. Likewise, the Bank of Japan will also have to do adopt policies to curtail the runaway appreciation of the JPY. Recall that the USD/JPY currency pair is closing in on the critical 100:1 exchange rate.

Will the Bank of Japan Adopt QE Policies?

Several months ago, policymakers and economists were deeply concerned about the yen’s appreciation, and they remain so to this day. When the Japanese yen strengthens to the degree that it has, Japanese exports become relatively more expensive to foreign buyers. This acts in a negative fashion for the performance of equities markets such as the Nikkei 225 index. When a selloff in equities markets in this use, finds typically get shifted to state-haven assets such as the JPY and gold bullion.

In summary, we can expect the extreme levels of volatility and anxiety in equities markets to propel gold to multi-year highs. Already the precious metal has breached a 2-year high, and it is climbing. The political turmoil across Europe and in Britain is driving the gold bugs towards the yellow metal. We are seeing huge amounts of capital transfers into gold shares, gold coins, exchange traded funds and gold futures. This safe money is on gold in 2016 and if Brexit fears are realized, the precious metal will prove itself in a big way.