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Gold might be about to defy 'conventional wisdom'
(Mario Tama/Getty Images)
Devotees dance as they are soaked in liquid saffron as it is poured over the monolithic statue of Jain sage Gomateswara during the first day of the Mahamastakabhisheka ceremony on February 8, 2005, in Shravanabelagola, India.
Gold is off to a blistering start in 2016.
Through the first five and a half months of the year, the precious metal is up an astounding 18.5% near $1,260 per ounce.
The strength in the precious metal has come amid increased demand from central banks and renewed demand from everyday people.
But prices have pulled back in response to hawkish rhetoric from Fed officials and the release of the April FOMC minutes.
On Tuesday, Atlanta Fed president Dennis Lockhart and San Francisco Fed president John Williams — a voting member — suggested that a June rate hike couldn't be ruled out. Then, on Thursday, Richmond Fed president Jeffrey Lacker indicated that he would be comfortable with four more rate hikes this year.
The hawkish Fedspeak, coupled with Wednesday's release of the April FOMC minutes, suggesting that a June rate hike is on the table if the economic data aligns, hasn't been kind to gold.
The precious metal has fallen about 2% since Tuesday morning and is back down to its lowest levels since the end of April. But support in the $1,250 area has so far managed to hold.
(Business Insider / Andy Kiersz, Data from Bloomberg)
In a Friday note to clients, Julian Jessop, head of commodities research at Capital Economics, reiterated his belief that the Fed will hike rates twice in 2016, and that Fed rate hikes won't derail gold's rally.
Here's Jessup (emphasis his):
The conventional wisdom, of course, is that Fed tightening is bad for gold, mainly because higher US rates can strengthen the dollar and increase the opportunity cost of holding commodities. Prices have indeed faltered this week in the wake of the hawkish FOMC minutes. However, there is surely more to say than this; after all, gold and silver prices actually rallied in the weeks and months after the Fed first raised rates last December.
(Capital Economics)
Jessup says that a couple of things are at work here. Initially, the resilience in gold was the result of safe-haven flows related to fears of a slowdown in the global economy. This was evident as gold prices gained as money plowed into the front-end of the US yield curve at the start of the year.
Once yields stabilized, gold continued to rally. And Jessup attributes the strength to two things: persistent weakness in the dollar and renewed interest in inflation hedges.
Here's Jessup again (emphasis added):
The upshot is that gold can still rally especially if US wage and price pressures continue to build. Indeed, even our forecasts assume that the Fed will continue raising rates only gradually and to a still-low level by past standards, which may fuel concerns that it is falling behind the curve on inflation.
So where does Jessup see gold going from here? He thinks $1,350 at the end of 2016.
And Jessup isn't the only one who likes gold right now. Russ Koesterich, head of asset allocation for BlackRock's Global Allocation Fund, says, "This is exactly the type of environment that has historically been most favorable to gold."
Specifically, Koestrich says that conditions are favorable for the yellow metal because real rates are low and inflation is on the rise. He cites Bloomberg data, which shows that gold has gained in 11 of the 12 years that fit that description since 1971, averaging a return of more than 35%.
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