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Why geopolitical events are not a good reason to buy gold

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The “inevitable correction once things calm down may damage the outlook for gold,” says Brien Lundin of Gold Newsletter.

By Myra P. Saefong, MarketWatch

Gold’s haven appeal amid mounting U.S.-Iran tensions and uncertainty in the Middle East could turn sour following the precious metal’s recent price rally to near seven year highs.

“The geopolitical instability is adding fuel to the fire,” said Maria Smirnova, senior portfolio manager at Sprott Asset Management, following a sharp rise for gold in 2019. “How lasting the boost to the gold price will depend on how the Iranian situation unfolds and whether it escalates,” and that situation may get “worse before it gets better.”

Still, it would not be a surprise if gold were to “consolidate its gains or correct after this pop” in prices, she said, while adding that a big downturn is not likely in the cards if that happens.

Gold’s latest rally comes on back of last week’s U.S. airstrike near Baghdad’s airport that killed General Qassem Soleimani, one of Iran’s top military commanders. On Sunday, Iran said it would no longer abide by the 2015 nuclear deal, which the U.S. had already pulled out of in 2018.

On Monday, February gold (GCG20) rose $16.40, or 1.1%, to settle at $1,568.80 an ounce on Comex, marking the highest most-active contract finish since April 9, 2013, according to FactSet data. Prices also tallied a ninth consecutive rise, the longest streak of gains since the 11-session climb ended on Jan. 5, 2018.

Brien Lundin, editor of Gold Newsletter, however, said he thinks “geopolitical events aren’t a good reason to buy gold.”

“The price almost always spikes before most investors can buy it and drops well before they can sell it,” he told MarketWatch. “So outside of high-frequency traders or insiders, everyone else ends up holding the bag.”

He also said these events “aren’t a logical reason to own gold since only those people in a specific troubled region might find the events a reason to actually own the precious metal.”

The gold market was “just beginning to get wider acceptance of the fundamental monetary issues that are driving the price of gold higher,” said Lundin. “Now the market may confuse the driver as being geopolitical in nature, and the inevitable correction once things calm down may damage the outlook for gold.”

Looking at the bigger picture, however, gold already was doing well before the developments in the Middle East. Gold futures ended 2019 with gain of almost 19%, the strongest performance for the year metal since 2010, when prices climbed by nearly 30%.

“The three main contributors to gold’s longer-term strength have been declining interest rates, slowing economic growth…and political instability,” particularly from concerns surrounding the trade wars and Iran,” said Smirnova.

And the “thesis for gold rests on the global macroeconomic picture and the expansionary monetary policies of central banks around the world,” she said.

Middle East developments aside, Lundin said he’s “confident that 2020 will be another great year for gold” and the “next five years will prove to be bullish for metals because the interest rate environment will be very supportive.”

“Debt loads are now so high that the U.S., as well as other development economies, simply can’t afford the debt-service costs that would come with even mildly positive real interest rates,” he said. “The current monetary regime isn’t likely to be replaced anytime soon, so zero or negative real rates are the new normal for the markets.”

The primary reason for gold’s rise in “central banks’ U-turns—specifically, the [Federal Reserve] has gone from raising interest rates to lower them and the [European Central Bank] rolled out stimulus,” said Smirnova. “Real interest rates both in the U.S. and globally rolled over right around the beginning of 2019.”

China’s easing move at the beginning of this new year is “in step with other central banks,” she said. “We continue to expect that banks around the world will maintain an accommodative stance” and such conditions are positive for gold and silver.

Gold has also managed to rise despite recent records for benchmark U.S. stock indexes and strength in the dollar. The Dow Jones Industrial Average (DJIA)  ended 2019 up 22.3% for its best year since 2017, while the S&P 500 (SPX) rose nearly 29% for its best performance since 2013.

The easing monetary conditions “led to the stock market rallying as the economic numbers have been relatively good on surface and lower interest rates contribute to an expectations of better economic growth,” said Smirnova, adding that she does not see stock market performance and gold performance as “contradictory.”

Gold often has suffered a decline when investors favor riskier assets such as stocks.

However, “investors are running out of options for how to manage the 30% gain they reaped in stocks last year, and the independent returns of gold may appear an increasingly attractive solution,” said Ryan Giannotto, director of research at GraniteShares, which offers the GraniteShares Gold Trust (BAR)

“One of the most fundamental misconceptions on gold is the market emphasis on price return,” he said. “What lends gold value in the portfolio is not that it is a better investment, but merely a different investment. This principle is the cornerstone of effective diversification.”

All told, the “buoyant stock market wasn’t necessarily a negative for gold in 2019, and won’t be going forward because this ever-easier monetary policy is positive for both equities and the metals,” said Lundin. The dollar strength last year also “didn’t affect gold too badly since after its initial surge, the greenback failed to maintain upward momentum.”

In 2020, the Fed will likely be another factor contributing to higher gold prices, he said. Fed Chairman Jerome Powell and company have “already set the bar very high, nothing that only a fundamental re-examination of their case for the economy would justify another rate hike.”

Then, when the stock market eventually demands another rate hike, the Fed will acquiesce, “as it must do to preserve economic growth,” and will send “an ominous message to the markets,” said Lundin. “This will send investors running to gold again.”

Myra Saefong is a MarketWatch reporter based in San Francisco. Follow her on Twitter @MktwSaefong.

See more at MarketWatch

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Bloom Magazine: Why geopolitical events are not a good reason to buy gold
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