Gold prices have been under pressure since last week. The U.S. jobs report exceeded expectations and put pressure on the yellow metal. Also dragged down were the gold mines. We should still look at whether the concern about gold is justified.
What happened?
The quite positive U.S. jobs report brought the gold price under pressure and pulled the yellow metal below $1700. This raised speculation whether the Fed will raise interest rates again sooner than thought. The rapid fall was more or less due to technical and speculative factors. In addition, large dubious sales volumes from Asia came at a time when the market was illiquid.
Interest Rate Policy
The gold price and the real interest rate have always moved in inverse relation. See Chart 1.
Chart 1: Real Interest Rates vs. Gold Price
The chart shows us the gold price to the real interest rate of the U.S. 10 year Treasury. We can see here that when the real interest rates become negative, the gold price reaches its highest phases. Conversely, when the real interest rate rises, the gold price comes under pressure. The U.S. jobs report turned out above expectations aroused the thoughts that the Fed raises interest rates earlier than expected again.
Why is this not a good idea?
Even though the jobs report was positive, many Americans are still without jobs. Stimulus checks that keep many Americans from looking for work are more rewarding than jobs. Incentives are lacking because wages are going lower instead of rising. Chart 2 shows U.S. real incomes.
Chart 2: Real Personal Income
As you can see, real income fell. This means that an increase in interest rate policy in the near future could leave many Americans unemployed in the long term. This, in turn, would reverse the recovery path that has been taken and possibly trigger a depression.
Earlier statements to follow Fed Chair Powell should not raise interest rates before the end of 2022 again.
The dollar issue
The Fed’s dollar index has recently found a bottom and gained momentum. Chart 3 shows the dollar’s performance in recent months.
Chart 3: Fed U.S. Dollar Index vs. Gold Price
Here one can see when the gold price shows weakness the dollar tends to get stronger. A stronger dollar could increase confidence in the U.S. dollar, which could put gold under pressure.
Inflation hedge, or not?
Consumer prices are not rising as strongly in July as they have in recent months. CPI rises to 5.4% in July. What does CPI mean? The Consumer Price Index or CPI measures consumer price changes on selected goods and services. These are selected based on our standard of living. In chart 4 you can see the CPI curve of the last months.
Chart 4: CPI Curve
The funny thing about the CPI is that it should show us how our cost of living is changing. They just forgot to put the biggest cost for all of us in the basket – taxes 🙂
Consumers are now paying far more for essential goods than they were a year ago. But why?
The keyword here is inflation. Inflation is the increase of the money supply in circulation. So when a higher money supply chases the same or fewer (shortage of goods) goods and services, price inflation occurs and consumers have to pay more for the goods and services. If wages do not increase in the same proportion, this means for the average citizen that he has less in his pocket at the end than before.
A little inflation has little effect on the gold price. This is what the recent past has shown us. But what if a little inflation becomes a lot of inflation or even hyperinflation. In that case, people will grab anything of value in order not to lose their wealth. That is the moment in which gold has its great hour. If the inflation figures will shoot uncontrollably into the sky, this will have a very positive effect on gold.
Is that possible?
Possible, but rather unlikely. At least the responsible people will do everything to avoid a disaster like this.
But…
The Senate just this week approved President Biden’s infrastructure plan. $3.5 trillion will be invested in infrastructure renewal over the next few years. This also means that the money supply will increase dramatically over the next few years. What this means for the inflation figures we have already explained above.
What about gold miners?
Gold miners have been dragged down with the plunge in the price of gold. Gold miners are, of course, dependent on the price of gold. When the price of gold rises, margins increase.
Many gold miners are raking in a lot of cash flow at $1800 gold. It also depends on the cost structure. Many gold miners can already cover their costs from a gold price of $1200.
For example, Mark Bistrow CEO of Barrick Gold (NYSE: GOLD) says that Barrick Gold can allocate long-term capital from a $1200 gold price. The break-even is below $1200. Barrick Gold is currently the second-largest gold producer in the world.
… so gold miners are more than well off with the current gold price and can generate a lot of cash.
… so why not just take a seat, buy the largest gold-producing companies and enjoy dividends until the outbreak? (No financial advice)
Sounds relatively unspectacular, but there are plenty of big gold producers that are relatively cheap to get right now. (Still no financial advice)
So is gold done for?
We believe that we are in the middle of a gold bull market and gold is taking a breather. Previous bull markets have shown us that.