There’s also the “debasement” trade, with investors reducing their holdings of sovereign debt and exposures to fiat currencies because they fear that their value will erode as the US and other overly indebted governments will eventually be forced to tackle their debt burdens by printing more money. That’s another macro reason to buy gold.
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At a more micro level, falling interest rates in the US — even with the inflation rate edging up as the impact of Trump’s tariffs starts to flow through — have been a factor in the sell-off of the dollar. Gold generates no income but for traders carries both holding and opportunity costs.
The slide in US rates – from mid-January the yield on the benchmark 10-year US government bond has tumbled from 4.78 per cent to 3.96 per cent — has helped reduce those costs of holding gold, while the inflation rate has, thanks largely to Trump’s tariffs, jumped from 2.3 per cent in April to 2.9 per cent in August.
Inflation data for September has been delayed by America’s government shutdown, but is expected to be released on Friday. Market forecasts are for another rise to 3.1 per cent, which would normally be a positive for the gold price, given bullion’s perceived role as a hedge against inflation.
There are, however, other developments looming that will overshadow the release of the inflation data.
Next week, the Federal Reserve Board meets amid expectations that it will cut its policy rate for the second time this year, although that isn’t a given, particularly if inflation is higher than expected.
Perhaps of greater significance, there is also a scheduled meeting of Trump and China’s President Xi Jinping on the sidelines of the Asia Pacific Economic Cooperation summit in South Korea that starts on Tuesday.
Trump’s initial response to China’s announcement of tightened controls over exports of rare earths and rare earth magnets was to angrily threaten 100 per cent tariffs on all US imports from China.
Almost immediately, however, he backed away, adopted a conciliatory tone and started talking about the “really great” deal – “fantastic for both countries, and it’s going to be fantastic for the entire world” – that he hopes to negotiate with Xi.
China’s dominance of rare earths, vital for most advanced manufacturing and weapons, means that Xi enters any trade discussion with Trump holding by far the more potent hand, regardless of Trump’s bombastic talk of America’s strengths.
The optimistic prospect of a trade deal that defuses the tensions between the world’s two key economies is a negative for the gold price.
Gold thrives in environments where there is fear, uncertainty and volatility. It is instructive that Wall Street’s so-called “fear index” – the VIX index – which measures market volatility, spiked in response to China’s new rare earths export rules and what appeared to be an abrupt rise in trade tensions, before subsiding when Trump started making more placatory noises.
Another possible ingredient in the mix that helped trigger the steep gold price fall is the fallout from the US government shutdown, which has impacted more than just the inflation data.
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With a lot of economic and financial data not being collected because workers have been furloughed and agencies effectively closed, commodity traders have lost access to the weekly report from the Commodity Futures Trading Commission that provides them with insights into how hedge funds and other institutional investors are positioned in gold and silver futures.
They are operating within an information vacuum, which tends to make investors nervous and defensive. Given how far and how fast gold and silver prices had run up – the gold price jumped about $US1000 an ounce in less than two months – it’s not surprising that some traders decided to reduce their exposure.
Having said that, the fundamentals for gold and other precious metals remain solid.
While the global economy has held up better than expected in the face of Trump’s trade wars, their full impact won’t be seen until next year.
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US and global debt levels remain extremely high and are still rising.
Geopolitical tensions may or may not wane, but they won’t disappear.
Central banks will continue to increase their gold holdings as a strategy for diversifying away from dollar-denominated assets, and they and their governments will also look for new trading partners and new currencies for trade after Trump has made it clear that historic relationships and institutions no longer matter to the US.
The US inflation rate is likely to continue to rise, which may or may not be transitory, and its deficits and debt levels will continue to build.
Political dysfunction – not just in America but in other major developed economies – will continue.
Gold may have given back what is really just a modest portion of the gains it has experienced this year, but it hasn’t lost its lustre. Most of the underlying factors that drove those gains remain.
The Market Recap newsletter is a wrap of the day’s trading. Get it each weekday afternoon.
