Gold Hits Six-Week High As Global Economy Falters

Gold prices have risen 4% over the past week, highlighting the extent of issues facing the global economy. At US$1,168 an ounce, the precious metal hit a six-week high on Saturday. Tellingly, it was also the sharpest weekly upswing since January. Bullion is threatening to enter a bull market again…and it’s about time it did.

Should you be worried? If you invest in shares, you’re probably a little concerned about the state of the markets. Not because gold prices are up, but because of what rising prices tell us about the rest of the economy. Right now, they’re telling us that markets are panicking. And why wouldn’t they be?

Global trade is plunging faster than anyone anticipated. It’s one of the big indicators foreshadowing a seismic global economic slowdown; I’ll have more to say on this a little later.

Over in Europe, Greece is heading for the polls yet again. If you thought we were done with that, you weren’t alone. Not only is the bailout agreement up in the air again, but Greece’s future in Europe is as well.

And then there’s the elephant in the room: China. We’ve had nothing but streams of negative economic data coming out of China recently.

Manufacturing figures in the world’s second largest economy dipped well below expectations this month. Between July and August, factory output fell to its lowest point in two years. At 47.1, the index measuring manufacturing is currently trending three points below the desired 50 points mark. Not that this comes as any surprise to anyone following China’s struggles of late.

Construction is slowing too, supported by falling Chinese demand for iron ore and lower steel production.

Worse of all, Chinese trade fell 8.3% year-on-year in July.

Oh, and let’s not forget Chinese equity markets either. I’ve stopped counting how far they’ve plummeted since June.

Chinese woes weigh on global markets, lifting gold prices

Predictably, the panic coming out of China spilled onto global markets too. US markets, led by the S&P500, shed US$4 trillion on Friday.

Of course, this market anxiety is good news for gold. Stock market selloffs are contributing strongly to bullion’s surge. But there’s an even bigger factor pushing up gold prices.

What am I talking about? The US interest rates. In fact, this has weighed on gold for much of the past year. Markets expected a September rate hike, which has kept a lid on gold prices in recent months.

What’s the relationship between US rates and gold prices? Simply put, a rate increase would boost the US dollar against other currencies. At the same time, a stronger greenback lowers the opportunity cost of holding gold. Why? Because gold doesn’t pay interest. It’s not a yield-driven asset.

But the likelihood of a US rate rise is shifting gears. What seemed a certainty, even a month ago, now looks hopeful at best. The US Fed hosed expectations for an imminent rate rise during its last meeting.

The Fed is unsure about lifting rates amid the uncertainty surround the world economy.

China’s poor economic data has recently sent the US dollar index crashing to a two month low. With China’s economic problems, and its desire to devalue the yuan, the likelihood of a US rate rise is lower than it has been for some time.

Without a US rate rise, the short to medium term future for gold looks positive. Global insecurity is forcing investors to flee to safety, opting for assets like gold over stocks.

It also means that gold is likely to climb further in the months ahead. For that to happen though it’ll need more bad news on global markets. Unfortunately for the world economy, it’s likely to get its wish.

Markets to trend down for the week

The coming week could prove difficult for both domestic and global markets. The ASX looks set to continue the dips we’re seeing on international markets.

Here’s ANZ’s talking about what the week holds for Aussie investors:

We’re expecting global stock markets to decline and commodity-exposed currencies like the Australian dollar to be weaken to start the week’.

Last week, the ASX200 finished 1.4% lower closing on 5,214 points.

Early on Monday, the share price futures index dropped 110 points to 5,058. Neither of which are good omens for the rest of the week. And it’s unlikely that there’ll be much positive news to buffet a further decline.

We may see gold prices edge higher on both domestic and international markets.

As mentioned, the one thing that could change this outlook is a Fed decision to lift interest rates. But you shouldn’t be pinning your hopes on this.

US rate rise imminent?

I’ve maintained in recent months that the Fed won’t make any calls on interest rates until early to mid–2016. That went against the market at the time, but that prediction is looking much likelier now.

I still feel that the global economy will undergo more, not less, duress before the US hikes rates. Markets may need to fall much further from present levels before we reach that point. That probably won’t happen this year, but don’t bet against it taking place in the middle of 2016. The Fed wants proof that the economy outlook is improving. Until it gets that proof, it won’t budge on rates.

Where does that leave us then?

The global economy won’t shake off China’s ills anytime soon. Authorities can slow the decline by injecting as much capital into the system as possible. That means rate cuts, stimuluses, yuan devaluations, and laxer lending requirements should follow.

The Chinese will go all out to lift exports to boost their economy. But as we’ve seen, these stop gap measures aren’t reversing the long term trend of decline. Even if China successfully boosts exports, there’s no guarantee that the demand will be there.

Why global trade is hollowing out

There’s a big problem with the world right now. It’s not often mentioned, because it doesn’t immediately affect investors. In the long run, however, everyone feels its effects.

Demand for goods, and trade in general, is falling to dangerous, recession-like levels. This is the newest global trend. How do we know this? Because freight rates are plunging.

Rates between Asia and Europe fell 60% over the last three weeks. What’s more, freight rates between Asia and the US dropped by an average of 8.9% in the same period. Why is that important? Because rates only fall when demand slumps.

Take a look at the Baltic Dry Index (BDI) too. The BDI is a key indicator of global economic health. It tracks the price of shipping major materials, like iron ore, by sea. Since the start of August, the BDI declined from a peak of 1,200 to 994.

But it could fall further still. With shipping companies under pressure to lift rates, their only recourse is to do just that.

There are plans across the industry to raise spot freight rates by $1,000 across the busiest routes. But again, the success of this depends on demand being there to meet export volumes in the first place. There’s no guarantee of that happening. And it suggests that demand could drop even further. Right now there simply isn’t enough global demand to keep the BDI above 1,000 points.

What does this tell us about gold?

Well, bullion prices could benefit on the back of slumping trade, and the economic uncertainty this foreshadows. That’s especially true of the short term trend in prices. Over a longer term, gold could certainly pare back losses from the last couple of years. If global trade is still in the process of bottoming out — watch out. We might be heading for a major recession across the developed world.

At the same time, surging gold prices tell us a couple of other key things.

One is that traditional assets, like stocks, aren’t offering much value to investors. That’s no surprise, as it reflects in the bearish market we’re seeing in equities now.

The other, more worrying, sign is that the global economy is heading for disaster.

There’s no getting away from it. The world is heading into its most uncertain period since the 2008 global financial crisis. The central banks did their best to paper over the cracks by injecting money into the economy back then. But few economies can accommodate another round of stimulus. At least not without heaping hundreds of billions of dollars in debt onto the rest of us.

This lack of confidence in the global economy is why gold is trading at six-week highs. But don’t bet against it gaining even more ground as these problems unfold.

Mat Spasic,

Contributor, Markets and Money


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Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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