Here’s the Real Story for Gold…

Do you want to get rich?

Well, despite the current price action, you should pay attention to gold!

I’m medium- to long-term bullish on the yellow metal. But, at the same time, I realise it’s not ready for prime time yet. That’s why I keep telling readers that gold could fall lower. There’s major support around the mid-US$1,100 zone. So, despite my ongoing positivity, I’m NOT bullish at the moment.

There’s no reason to drive gold prices higher now. The greenback is relentless. But, given a significant amount of analysis, you should expect the unexpected. Markets tend to react how you don’t expect.

In that case, I believe the gold price could turnaround soon…

Gold bull market looming

There’s a good chance ― not a guarantee ― that gold could breakout into a bull market in December. I’m not just calling for a small breakout either. Gold could close above US$1,377 per ounce ― the major resistance level. I know that claim might sound ridiculous. But, don’t forget, gold short positions are at an all-time high!

We could see the greatest short-squeeze in history. It could start by a real war breaking out in the Middle East, a policy error in Europe, or rising interest rates in the US.

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It’s a big call, indeed.

The critics certainly disagree.

Higher interest rates normally drive the US dollar higher. That’s what’s happening right now. When the greenback shoots higher, gold prices tend to fall lower. There’s an inverse relationship between gold price and the US dollar.

And, considering at what’s happening today, a surging greenback could delay the gold bull market ― especially with a major emerging market crisis brewing in the background. That’s a risk. Traditionally, when emerging market crises play out, the US dollar skyrockets against most currencies around the world.

Here’s what happened during the Asian (emerging market) crisis of 1997/98:

Graph of Trade Weighted Broad US Dollar Index

Source: Sunshine Profits

[Click to open in a new window]

The trade weighted broad (TWB) US dollar index is a weighted index, comparing the US dollar to most global currencies. The US dollar index surged during the Asian crisis ― especially between July 1997 and July 1998. Here’s what happened to the major Asian currencies at the time:

Graph of Asian currencies between June 1997 and July 1998

Source: Economicshelp.org

[Click to open in a new window]

Punters fled emerging markets and bought US dollars. Whether we like it or not, the US dollar is ― and has been ― the world reserve currency since the First World War. The US government has never defaulted on its national debt, technically speaking. That’s why investors run to the US dollar for protection during a crisis.

More to the story…

Prior to the emerging market crisis of 97–98, the US Federal Reserve doubled interest rates to fight inflation:

Graph of Effective Federal Funds Rate

Source: St Louis Federal Reserve

[Click to open in a new window]

The doubling of interest rates hit emerging markets hard. At the time, Southeast Asian economies held a significant amount of dollar denominated debts. Most countries were running current account deficits, as well. When the greenback strengthened, it cost more for international borrowers to repay their debts.

Few countries and firms could repay their debts…

It ended with mass defaults

If the US dollar skyrockets again ― with interest rates moving higher over the next two years ― emerging markets could face a similar crisis to the 1990’s. Turkey, Venezuela, and Iran are already feeling pain.

And it could get worse…

The US Federal Reserve plans to raise interest rates another two times this year, and three times next year. That could put tremendous pressure on emerging market economies in the future ― they aren’t in the best health today. 

Here’s The Financial Times on 20 July (my emphasis added):

If it walks and quacks like an emerging markets balance of payments crisis, is it really an emerging markets balance of payments crisis? We are not yet there, and hopefully it will not come to one. But the patterns recently displayed by global financial markets are sufficiently redolent of capital flight from poorer countries in the past that caution is in order.

Start with foreign exchange. In the second quarter emerging markets currencies had their worst fall in seven years. July started better, but the downward pressure is back on a steady course of interest rate tightening in the US. This attracts capital to the dollar.

Equity investors have been pulling money out of emerging markets for 10 weeks straight. So have bond investors, though that outflow appears to have been staunched — for now.

Seasoned market watchers have seen this movie many times before. In times of low global interest rates, emerging markets are flooded with cheap lending from the rich economies, reflected in large current account deficits.

If we’re right, there could be another emerging market meltdown by 2020. History shows what this could mean for gold:

Graph of US Federal Funds rate and gold prices

Source: Truewealthpublishing.asia

[Click to open in a new window]

You might be shocked. But gold consolidated sideways ― when US interest rates doubled ― before the Asian (emerging market) crisis of 1997–98. That happened, even though interest rates doubled, and the greenback surged. Remember, the US economy was strong ― there was little reason to buy gold at the time. Confidence in the global financial system was high, according to multiple IMF papers.

The yellow metal didn’t surge into the crisis because there were no warning signs! But, it crashed during the meltdown ― similar to almost every financial crisis since 1971.

Get ready.

The mainstream media didn’t expect an emerging market crisis in 1997. The Financial Times ― and many other mainstream papers ― have warned about an emerging market crisis multiple times today

The writing’s on the wall.

Will gold rally into the meltdown?

Who knows!

But, I think it will ― the ingredients look right. Uncertainty and volatility are low. There’s no cause of alarm yet. Global central banks are also leaning towards higher interest rates, suggesting everything is OK. But an abrupt policy change ― thanks to an emerging market crisis ― could trigger a massive gold rally.

That happened during early 2016!

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If a policy change doesn’t happen though, don’t worry. Historically, as we showed our readers at length a few weeks ago, gold tends to rally with higher interest rates. Anyone who tells you otherwise needs to review their history!

Plus, as the European Central Bank becomes more positive about its (failed) economy, traders are likely to get nervous ― especially if we see more political issues in Europe. Europe’s economic and political troubles could serve as a distraction to what’s happening with emerging markets.

The sentiment towards gold could change soon…

There’s a lot that could go wrong around the world today. If the situation gets worse, gold could rally with rising interest rates in the US. Remember, gold short positions are at an all-time high! The last all-time high was in early 2016, prior to a major policy change by the US Federal Reserve. Gold rallied nearly US$200 per ounce when shorts covered!

There’s a good chance it could happen again. But history won’t repeat the same. There’s likely to be a different reason to cause a short covering rally.

I hope you’re ready for it…

Regards,

Jason Stevenson,
Resources Analyst, Gold & Commodities Stock Trader


Jason Stevenson is Markets & Money’s resource analyst. He shares over a decade’s worth of investing and trading experience across resource stocks and commodity futures and options. He originally studied accounting and finance at Curtin University, where he was awarded a first-class honours degree. His professional background stems across high-net-worth, top tier accounting (corporate finance, tax and auditing), and sell-side equities research. Before joining the team at Markets and Money, Jason worked at boutique firms which advised fund managers and high-net-worth clients on where to invest. Whether it’s gold, crude oil, copper or an obscure metal like vanadium, you can rely on an in-depth analysis in Markets and Money. Jason also brings you extensive macro, political and geopolitical analysis from around the world. He leaves no stone unturned when it comes to telling the truth. Jason is also the lead analyst of Gold Stock Trader, a premium service for investors serious about precious metal stocks. Websites and financial e-letters Jason writes for:


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