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Gold: One of the Most Interesting & Complicated Stories of 2016

December 15, 2016
Investment advice for the fluctuating gold market in 2017.

Gold, and the companies that mine, process, and distribute the precious metal, have had an interesting 2016. After beginning the year at the lowest levels of the decade, $1,060 an ounce, gold rallied more than $300 an ounce to the mid-$1,300s by August. Then, after the ebbing of election uncertainty, the metal fell back below $1,200. Shares in mining stocks and exchange-traded funds also hit multi-year highs earlier in the year.

Here’s a look at what's been driving the precious metals complex this year and what could lie ahead.

Status? It’s Complicated.

Gold is a complicated investment vehicle—not necessarily the mechanics of buying or selling it—but the reasons why investors buy gold are varied. To some, gold is the ultimate safe haven, the original currency, and an alternative investment that may withstand the debasement of paper currencies. To others, it is a sensible portfolio diversifier with a low to negative correlation to stocks and other key asset classes.

One of the major drivers of gold in 2016 has been the negative interest rate environment seen in a few advanced economies in Europe and in Asia. Other central banks may turn to negative interest rates in an effort to stimulate economic growth, and some global investors may turn to gold as a hedge against economic uncertainty and continuing monetary policy accommodation. Also, some may say it has lived up to its name as a safe haven vehicle, with short-lived but significant spikes higher after the unexpected Brexit vote and the election of Donald Trump as president. As each of these events unfolded, and uncertainty receded, so did the price of gold.

Consider the Bigger Cycle

The 2016 rally in gold and precious metals stocks emerged after a five-year bearish phase from 2011 to 2015, says Rob Lutts, CIO of Cabot Wealth Management and author of The Great Game of Business: Investing to Win. "Capital spending by the mining sector has declined dramatically over the bearish phase in gold and precious metals. Specifically, capital costs announced in 2016 by the mining industry that produces all precious and industrial metals have declined by about 80%," Lutts says.

"This means the supply and production capacity of gold, silver, and most other industrial metals has declined materially. This decline in supply is coinciding with rising investor demand as investors act to protect portfolios against the negative impact of currency debasement," Lutts said.

An Inflation Hedge?

Historically, gold and precious metals are thought to be an inflation hedge. Although the quantitative easing and monetary policies by advanced central banks around the globe since the 2008 global financial crisis have yet to unleash a wave of higher inflation, some believe that risk remains.

Lutts points to concerns about the potential for future inflation as one of the factors supporting gold gains in 2016. "I suspect investors are beginning to realize what my economic professors at Babson College told me about more money chasing the same goods and services. It can only mean one thing: inflation."

Lutts is positive on the outlook for gold ahead. "We cannot grow money supply 5% to 6% year after year and not expect that will affect the prices of goods. Expect inflation to rise gradually as wages and higher commodity prices find their way into the economy. We would not be surprised to see gold trade at over $1,500 sometime in the next 24 months—up 20% from current levels," Lutts says.

Of course, there are two sides of the coin to every market view. Here are some factors that could derail the uptrend in the gold market, Lutts says:

  • Deflation
  • Higher interest rates that will compete for investor funds
  • Fiscal responsibility in Washington and deficit reduction

As the calendar flips to 2017, there will be a new administration in Washington. Treasury yields have already jumped higher in anticipation of the potential for future inflation if large infrastructure spending proposals are enacted. The problem of higher inflation is not something investors have heard much about in the past 10 years. 

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