Deflationary trends across most of the global economy have not abated through the first half of 2015, dragging the gold price lower as the dollar remains the main beneficiary of such developments. July saw the largest monthly decline for spot gold in almost exactly 2 years, when the bear market that began in 2013 hit full swing.
Gold vs. the Dollar
As the comparative chart above indicates, the strong inverse correlation between the Greenback and the gold price has been especially clear over the last 12 months. The COMEX paper gold price was down about 1/3 percentage point this morning, below $1,089/oz, while the spot gold price for physical bullion fell by about twice that margin to just above $1,090/oz. Meanwhile, the dollar rose about 0.6% against a basket of its peer currencies according to Bloomberg’s DXY dollar spot index.
Although the general drop in commodities over the past year’s down cycle, and especially over this summer, are having an impact on falling gold prices, the main driver is—and will almost certainly continue to be—the purchasing power of the dollar as the Federal reserve approaches its first adjustment to its benchmark interest rate since before the financial crisis. As the USD likely approaches its cyclical top and gold prices potentially bottom, that trend could entirely reverse by the end of the third quarter.
Role of the Federal Reserve
Though the momentum for a September rate hike by the Federal Reserve is predominantly seen as bullish for the dollar, the fact remains that inflation is running short of Fed targets, and tightening monetary policy will only create more deflationary pressure. The central bank (like most of its kind) is generally trying to spur inflation, which would run counter to the September (or even December) rate increase that the markets are expecting.
Keeping the interests of the Fed in mind, a shallower-than-expected rate increase, perhaps of 6.25 basis points (1/16%) rather than the 12.5 bp (⅛%) FOMC participants have projected, could have the effect of depressing the dollar and lifting gold. With seeming strength in the labor market and strong GDP numbers released today, the pressure on the Fed to adjust the near-zero federal funds rate mounts. This seems to be one logical way for the Federal Reserve to maintain the credibility of its calls to imminently put interest rates on a path toward normalization while still accomplishing its underlying goal of creating inflation.
Uncertainty in China
In addition to closely tracking central bank policy and the dollar, trading momentum in gold will also feel the effects of which direction the Chinese economy (the world’s second-largest) is headed. China is not only among the world’s leading consumers of gold, as is frequently publicized, but is also its most prolific producer of the yellow metal. The weakness in global commodity prices has coincided with the downturn in Chinese equities over the last month, not only raising concerns over investments in China but also prompting many large mainland shareholders to sell their gold holdings to cover piling losses in stocks. If the medium-term situation steadies in the Asia-Pacific markets—as China is the bellwether for the fastest-growing region on the globe—after weathering the volatility storm of July, don’t be surprised if gold prices enjoy a rally even amid the current bear market.