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Is the 2016 Gold Rush On? Keep an Eye on Central Banks

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March 9, 2016
Panning for gold: How do the interest rate policies of central banks affect the price of gold? What traders need to know.

Gold bulls charged out of the starting gates in 2016 at breakneck speed. Early-year stock market volatility triggered safe-haven investment flows, and investors around the globe piled into the gold trade, propelling gold futures higher by nearly 20% since the start of the year.

"It's been a pretty incredible run over the last two months. It started as a safety play, but even as stocks started rallying back, people were still buying gold," said JJ Kinahan, chief market strategist at TD Ameritrade.

Low Correlation to Stocks

As a so-called alternative asset, historically, gold boasts a low correlation to the stock market. When the stock market stumbles, investors may turn to gold as a safety play. Historically, when the S&P 500 has plunged by more than 4.4% in a week, the correlation between stocks and gold falls to -15%, according to the World Gold Council.

Although the rally in gold earlier this year may have been triggered in part by the stock market correction that took the S&P 500 to a low of 1810.10 on February 11 (off its all-time high at 2134.72 hit last May), stocks have since rebounded smartly. The S&P 500 is now testing key resistance at 2000, but gold continued to gain.

The S&P 500 has scored a stunning recovery off its February 11 low. The S&P 500 closed out the week ending March 4 with only a 2.2% decline year to date. However, within the S&P 500 materials sector, the gold subsector has posted a whopping 45.1% year-to-date gain, according to data from S&P Global Market Intelligence.

Global Central Bank Watch

The latest leg up in the gold market is partly technical, but may also be related to currency concerns, Kinahan said. The European Central Bank (ECB) is set to meet this Thursday, and forecasts are for a deeper monetary policy that cuts into negative interest rate territory. Gold bugs have viewed the turn to negative interest rates (by a number of major global central banks) as another form of currency debasement.

Credit Suisse forecasts a rate cut by the ECB to bring its deposit rate down to -0.4%. The firm also expects the ECB to initiate another round of quantitative easing of €80 billion per month.

"People who are losing relative value in their currency will sometimes buy gold as a hedge," says Kinahan.

Digging Deeper: Gold Miners

Gold mining stocks are viewed as the most common way to express a perspective on the gold market. But, gold mining companies have many risk factors to consider, from company management to labor costs as well as equipment and land leases. All these factors, plus the price of gold, can affect the pricing of gold mining stocks.

Nevertheless, gold mining stocks can offer clues for investors.

"We see the recent increase in gold to be driven by investor risk preference rather than from a fundamental increase in demand or cutback in production of the commodity," says Erin Gibbs, equity chief investment officer at S&P Global Market Intelligence.

"When you look at the miners, the median stock is trading at a discount of about 20%, not a premium to its net asset value and book value. Since the market is pricing the average stock at less than the present value of their assets, I feel this implies a negative longer-term outlook for these stocks and the price of gold from today’s prices," Gibbs says.

"If global equity markets stabilize and investor risk appetite increases, then gold could give up some of the recent gains. At the very least, we might expect some price stabilization of the gold index," Gibbs says.

Gold index versus S&P 500 (SPX)

FIGURE 1: GOLD VERSUS S&P 500 (SPX) SINCE MARCH 2013.

This is a chart of the relative performance of an index of gold versus the SPX starting in March 2013. The SPX outperformed gold mining stocks by a wide margin in the last three years. Recent weakness in the SPX may have contributed to the most recent rise in gold mining stocks. Data source: NYSE. Image source: TD Ameritrade Trade Architect. For illustrative purposes only. Past performance does not guarantee future results.

How to Watch Futures

For traders considering a position in the gold market, there are several ways to trade a position in the metal. "There are gold mining shares for those who don't want to trade futures. It’s like playing oil companies to gain exposure to oil," Kinahan says.

Trading futures can be a little confusing, Kinahan says. TD Ameritrade clients can learn more about futures contracts, including items like tick size and margin requirements, through the Futures Trader feature on the thinkorswim® platform. See figure 2. 

Futures Trader in thinkorswim

FIGURE 2: FUTURES TRADER IN THINKORSWIM.

After logging on to the platform, find Futures Trader by clicking Trade > Futures Trader. To get this layout, look in the upper, right-hand corner and click the grid. Select 1x3 grid and type the symbols of futures contracts you want to follow. Data source: CME. Image source: the TD Ameritrade thinkorswim platform. For illustrative purposes only. Past performance does not guarantee future results.

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