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Four Reasons To Look For A Higher Gold Price And One To Suggest A Decline

It’s a perfect storm for the gold price now amid skyrocketing inflation and the possibility that a Russian invasion of Ukraine is imminent. The yellow metal surpassed $1,800 an ounce...

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This story originally appeared on ValueWalk

It's a perfect storm for the gold price now amid skyrocketing inflation and the possibility that a Russian invasion of Ukraine is imminent. The yellow metal surpassed $1,800 an ounce briefly in January but has largely failed to hold that level for an extended period over the last year.

Global_Intergold / Pixabay - Valuewalk

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The gold price has toyed with $1,800 an ounce at various times throughout 2021, but finally, it is back above $1,900 an ounce, a level it hasn't seen since the end of May. The yellow metal surged to $1,900 on February 17, when tensions between Ukraine and Russia heated up from simmer to boil. Since then, the gold price has been hovering between $1,890 and $1,910 an ounce, close to its highest levels in eight months.

Safe-Haven, Inflation Demand For Gold Renewed

According to the World Gold Council, the LBMA Gold Price PM fell less than 1% in January to $1,795 an ounce. However, according to Kitco News, the yellow metal has since rebounded and is up by almost 4% for the year. It seems the increased likelihood of a regional war between Ukraine and Russia has given gold prices a boost, which should ratchet up inflationary pressures further.

"Gold is having a great month as investors scramble for both safe-havens and inflation hedges," Edward Moya of OANDA said in an email on Tuesday. "Russia-Ukraine tensions continue to intensify, and that is driving a massive move across commodities. The likelihood of a regional war seems high, and that will likely keep inflationary pressures elevated for much of the year. Bullion seems like it is taking a little break right now, but investors will soon be saying, 'I love gold' as geopolitical and growth concerns will drive safe-haven demand."

Moya sees tentative resistance for the gold price at around $1,920 an ounce, but if it breaches that level, he sees the next resistance level at around $1,950. Earlier this month, the World Gold Council said that gold was already displaying its safe-haven qualities.

Interest in the metal was already high last month before the specter of war arose. The council said gold volumes rose to $139 billion per day last month, a 71% month-over-month increase that was 7% higher than last year's average.

Ultra-Bullish View Of The Gold Price

As always, some market watchers hold an ultra-bullish view of gold. Chris Vermeulen told Kitco News that gold is likely to reach $2,700 an ounce in one year and then soar to $7,400 in five years. He described the current situation as "a pretty major supercycle in precious metals." Vermeulen believes the current cycle started in 2019 and will last about five years.

He noted that 2022 has been an exceptionally challenging year for equities following an extended bull market in the asset class. Vermeulen also said that when the equity markets reach the later stages of the cycle, commodities "come to life." He expects gold miners and commodities to outperform the broader equity index this year.

However, Vermeulen also said we have to watch how the stock market sells off if it declines. He believes that if stocks go into a panic phase like what we saw in 2020 and plunge straight down, then gold and miners will be pulled down too. However, Vermeulen added that gold and miners will "probably hold up the best and do OK, compared to the other indexes," even though they will probably sell off.

On the other hand, he thinks that if the market grinds down more slowly, it will create the "perfect scenario for precious metals." Typically, the dollar index is inversely correlated to gold, but it has rallied alongside the yellow metal over the last three weeks. Vermeulen expects the trend to continue.

A Bearish View Of Gold

Not everyone is convinced that gold will continue to move higher despite the runaway inflation and boiling tensions in Ukraine. UBS strategist Joni Teves told CNBC earlier this week that she believes the recent strength in the gold price will be "short-lived." She also predicted a decline to $1,600 an ounce by the end of the year.

Teves made her remarks on Monday before Russian President Vladimir Putin ordered the Russian military to move into two parts of eastern Ukraine that side with Russia but after he said that the Kremlin would recognize their independence from Ukraine. She expects the gold market to go back to focusing on macro drivers like real rates, the U.S. Federal Reserve, and the outlook for growth.

What About Interest Rates?

Traditionally, market watchers see interest rate hikes as bad for gold because, in theory, investors would want to unload their gold and pour their money into bonds, which benefit from higher interest rates, versus the unyielding nature of gold. However, things aren't so simple.

The consensus has been for the first Fed rate hike to come in March, but OANDA's Moya believes the growing tension between Ukraine and Russia could remove the risk of a Fed rate hike in March. If that occurs, investors' appetite for risk could increase on the back of a less aggressive Fed while geopolitical tensions have already been largely priced in. However, even in that situation, it doesn't mean clear skies for stocks.

"Geopolitical tensions will continue to undermine economic growth, and that should keep equities very choppy until the Russia-Ukraine crisis has a clear conclusion and after the financial markets have a firmer handle on how aggressive Fed tightening will be," Moya added.

Another View On Interest Rates And Gold

In a recent note for Mymikan Capital, Daniel Oliver explained why he believes gold is positively correlated with nominal rates. He said rising rates increase the need to hold dollars to pay interest, which strengthens the dollar but also reduces the value of the assets on the Fed's balance sheet, which back the dollar.

Oliver added that rising rates also accelerate the next economic downturn. St. Louis Fed President James Bullard called for a 1% increase in the federal funds rate by July 1, and then yields jumped, taking the 10-year Treasury yield to 2.05%. Gold tumbled alongside the S&P 500 while the dollar shifted higher. A day later, gold was up, the dollar index was unchanged, and the S&P was down more than 2%. All that happened before the earliest rumors of an impending war with Russia, which gave gold a boost.

Oliver also explained why it's not as simple as saying that gold is negatively correlated with interest rates. He pointed out that if the Fed raises the fed funds rate by 1%, it will cause an "earthquake in bond land," but the increase in inflation from 7% in December to 7.5% in January means that real rates fell half a percent.

So What Does All This Mean For Gold?

Ultimately, gold's value as an inflation hedge is at best questionable, given that history shows examples of when gold did well and poorly during inflationary periods. The yellow metal's relationship with interest rates is equally as dubious because history also shows examples of both positive and negative correlations between rates and gold.

However, gold is one place investors go in search of a safe haven during times of uncertainty, which may be why there are both bullish and bearish periods of high inflation and rising interest rates. There's no denying that the tensions between Russia and Ukraine are creating uncertainty in the world, so it would seem that, at least for now, the yellow metal may hold onto its current position at around $1,900 an ounce.

On the other hand, it would seem that some profit-taking may be in order, which could restrain gold prices in the near term, keeping it range-bound between $1,890 and $1,920 an ounce. The pieces are certainly in place for gold prices to run higher in the long term, with the possibilities of runaway inflation, a war between Ukraine and Russia, a Fed mistake, and an economic downturn pitted against rising interest rates.

However, while the seemingly pro-gold factors outnumber those that tend to run against higher gold prices, history shows that anything can happen. Thus, investors are advised to be vigilant and avoid making knee-jerk reactions based on emotions.

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