Weak U.S. Dollar and Inflation Bullish for Gold Prices

The outlook for gold prices remains bullish. Gold prices are up 7.7% in 2017 and trading near a three-month high of $1,240 per ounce. Investors are attracted to precious metals like gold and silver as a hedge against economic uncertainty. But the broader markets are trading at record levels. So why are gold prices rising? For a number of reasons: technical buying, an overvalued stock market, a weaker U.S. dollar, and lowered expectations for a rate hike by the Federal Reserve. As a result, the outlook for gold remains strong. At the end of 2015, Wall Street was predicting that gold prices would tumble around five percent in 2016. That didn’t happen. Gold ended 2016 up around 8.5% at $1,151 per ounce. Gold prices soared in January and February 2016 on weakness in the U.S. economy and growing fears of a global recession. By July 2016, gold prices had increased almost 30% to a two-year high of $1,377 an ounce. In the second half of 2016 though, gold prices started to give up ground. First, gold prices fell in October on positive economic news and expectations that the Federal Reserve was going to raise rates. Higher rates are a vote of confidence for the U.S. economy and erode demand for non-interest bearing assets like silver and gold. Gold prices fell in the weeks after Donald Trump won the U.S. election. Wall Street got behind President Trump and believed his economic policies would be good for corporate America. Again, investors turned to gold as a hedge against economic uncertainty and everything suggested the U.S. economy was strong; as a result, investors shunned gold.

Gold Is a Safe Haven Asset in 2017

It’s been a different story though since late December. Overall, the strength or weakness of the U.S. dollar has the biggest impact on gold prices. That’s because gold is priced in U.S. dollars and reflects investor confidence in the greenback. As a result, gold has a strong inverse relationship with the U.S. dollar. For gold to have a sustained rally, the U.S. dollar needs to be weak. The U.S. dollar lost more than three percent of its value against a basket of global currencies in January, including the yen and Swiss franc. In addition to a weak U.S. dollar, gold has been getting a boost from the Federal Reserve. The Fed raised rates in December and was expected to raise rates four more times in 2017. Since the Fed failed to raise rates at its last meeting in early February, investors have been weighing the strength of the U.S. economy. This suggests the U.S. economy remains fragile, which also has the added effect of weighing down the U.S. dollar. As a safe haven asset, investors are also concerned about a major stock market correction. According to the Case Shiller CAPE Ratio, the S&P is overvalued by 80.25%. The ratio has only been higher twice, in 1929 and 1999. Each time, it was followed by a crash.1 Economic uncertainty in Europe is also making gold an attractive investment. Europe is the world’s largest economic region, so a slowdown in Europe could have a major impact on global growth. Lastly, there is concern about how Donald Trump’s economic policies will actually pan out. Many see President Trump’s “America First” platform as a form of protectionism and are afraid of a trade war with China. Where will gold prices go in 2017? Understanding the relationship of gold with the U.S. dollar and other currencies can be very useful in helping investors understand where and how to invest. It’s also important to appreciate how interest rates, inflation, stock valuations, and geopolitical and economic conditions affect gold prices.

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  1. “U.S. Stock Markets 1871-Present and CAPE Ratio,” Yale University, last accessed February 12, 2017; http://www.econ.yale.edu/~shiller/data.htm.