Many investors around the globe rotated to the perceived safety of gold in the first-quarter, fueling a 21% increase in gold demand year-over-year, according to some industry reports. As a reminder, stocks dropped by about 10%, as measured by the S&P 500, during the quarter.
The 21% increase in demand for gold was the second largest jump on record, the World Gold Council said. "This increase was driven by huge inflows into funds, fueled by worries over the global economic and financial landscape," according to the Gold Demands Trends Q1 2016 report.
"While there’s no proof that gold works in times of crises, many still view gold as the ultimate safe haven," noted JJ Kinahan, chief market strategist at TD Ameritrade.
Interestingly, while stocks rebounded off their first-quarter low and the S&P 500 now trades up nearly 1% on the year, the gold market has hung onto its first-quarter gains. Nearby gold futures are up just over 21% year-to-date.
Currency, Asset, Hedge, Store of Value?
Gold is many things to many investors. Called the original currency, some view it as an alternative currency even in today's modern society with paper or fiat money. Gold bugs view it as an insurance policy against global financial market collapse or recession. Others view it as an inflation hedge or a non-correlated asset to potentially help diversify a portfolio.
Let's rewind to 2015: last year was not pretty for the gold market. Some funds that hold physical gold dropped by about 10% last year. "Many commodity prices fell last year. Some of it had to do with dollar strength. It may have gotten overdone," Kinahan said.
As a dollar-denominated commodity, gold (like oil) often tends to have an inverse relationship with the U.S. dollar index. As the dollar goes up, dollar-denominated commodities like gold and oil tend to become cheaper on the global markets. So a stronger dollar tends to weigh on gold, while a weaker dollar can be supportive.
Kinahan pointed to three major factors which have injected a high level of uncertainty into the marketplace, which may have played a part in gold's strong first quarter gains:
- Interest rate uncertainty: when and by how much will the Fed hike rates in 2016?
- Crude oil: after dropping to around $26 per barrel, it rebounded toward $48.
- Election year uncertainty.
"We have no reason to think any of these things will be resolved until the fourth quarter," Kinahan says.
The Negative Rate Syndrome
Another relatively new factor on the global market scene are the impact of negative interest rates. A number of global central banks including the Bank of Japan and the European Central Bank have shifted to negative rates in an attempt to jumpstart sluggish growth and inflation environments. This in turn has been of benefit to the gold market.
"There’s a cost to store gold and it pays no dividends. Because central bankers around the globe have negative interest rates this makes gold even more attractive," says Sam Stovall, managing director at S&P Global Market Intelligence.
It has been an almost perfect storm for gold bulls. Other supportive factors include "weakness in the U.S dollar, the Federal Reserve continues to postpone when they are likely to hike rates next, and global economic uncertainty remains," Stovall says.
All That Glitters May Not be Golden
The price of gold, along with the VIX and bond prices can be used as "warning signals" for the stock market, Kinahan says. "When these three are going up many investors see it as a warning signal that people are going toward safe-haven investments," he said. Stock market investors often use this as a signal that it’s time to look to add some portfolio protection, he says.
Investors can monitor the correlation between the S&P 500 and nearby gold futures using an overlay chart. See figure 1 below, which shows a 10-year weekly chart of the S&P 500, with an overlay of gold futures.
To create the chart in figure 1 in the thinkorswim platform, click the Charts tab > Type “SPX” in the symbol box and press enter > Click Studies > Quick Studies > Compare With > Custom Symbol > Type “/GC” and press enter.