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Five Reasons Now Is the Time To Increase Your Allocation To Gold

February 21, 2017

In December, we argued gold’s post-election decline didn’t reflect its fundamentals and that now could be a good time to add some to your portfolio. It just so happened that shortly after, the price began rising.

The yellow metal is up almost 8% since the beginning of the year—and the outlook for 2017 is bright. Net bets on higher future prices have almost doubled since January. Assets held by gold ETFs are up 34% from their December lows.

Given its recent surge, is gold still a “buy?”

Reason #1: Optimism around Trump Is Fading Away

With gold having its best January since 2012, many are expecting a pullback. While a retrenchment is possible, given the shifting political landscape, we think it has further to go.

Historically, the yellow metal has done well in times of uncertainty. While uncertainty rose following the election, gold fell. This was due to optimism surrounding Trump’s pro-growth policy announcements.

However, since the inauguration, some optimism has evaporated, and investors are recalibrating their expectations and timelines for actual policy implementation. 

As uncertainty surrounding immigration policies, the future of Obamacare and Dodd-Frank, and tax cuts continues, gold will be a likely beneficiary.

Are Investors Too Complacent?

The change in the drivers of economic growth is also good for gold. Since the election, it has been politics—not central banks—steering markets higher.

This represents a major sea change. While the Fed’s actions post-financial crisis have been predictable, Trump is anything but. Therefore, we can expect twitchier markets ahead. Mohamed El-Erian has coined this period “Phase III” of the Trump Rally.

Given this is the second longest period in stock market history without a 10% correction, investors should proceed with caution.

Higher volatility may very well be the story of 2017.

Reason #2: The Dollar Is Weakening

 Increasing ambiguity has led to another positive development for gold—the drop in the dollar. The dollar index hit a 14-year high back in December. It then went on to have its worst January since 1987.

The dollar’s decline helps gold in two ways. First and foremost, gold and the dollar have a strong inverse relationship. When gold rises, the dollar falls—and vice-versa. Secondly, as gold is priced in US dollars, when the greenback falls, gold becomes cheaper for foreign buyers.

Reason #3: Europe’s Election Calendar For 2017 Spells Trouble

The situation in Europe also looks promising for precious metals. Following the “Brexit” vote last June, gold rose 7% in less than two weeks. If you thought Brexit cast doubt over the future of the EU, wait until you see 2017’s political calendar.

National elections are taking place in France, Germany, and The Netherlands. In all three countries, outsiders are gaining ground on traditional “centrist” parties. Greece is also back in the news with its perennial fiscal problems. That’s not to mention Italy, where a banking crisis is emerging.

Besides political happenings, the developing economic picture looks positive for gold.

Reason #4: Reflationary Revival

On the back of improving economic data, the Fed raised interest rates last December for only the second time since 2006. They also laid out a plan to hike rates three times this year. As a result, equities moved higher while bonds sold off.

As expected, gold fell on this announcement. Higher rates are negative for gold as it increases the opportunity cost of holding the metal. While the rate hike knocked gold, the chances of more coming in the near-term fell after the disappointing January jobs report.

Adding to the optimism is the return of inflation. In December, the consumer price index (CPI) recorded 2.1% year-over-year growth. Expected inflation, measured by the 10-year breakeven rate, has consolidated above 2%. Both numbers are at their highest levels since 2014.

As the biggest driver of the gold price is real rates, this is a huge plus for the metal. At the moment, the negative correlation between gold and real rates is the strongest since records began in 1997.

Given the current setup, the January CPI number could have enormous implications. If it comes in over 2%, it may force the Fed to reluctantly raise rates in March. Higher rates will further tighten financial conditions. Given the elevated public and private debt levels, it would likely weigh on economic activity.

Reason #5 The Last Time This Happened, Gold Soared by Double Digits

 Following these developments, gold moved above its 100-day moving average (MA) last week. This is very bullish as the 100-day MA acted as both a floor and a ceiling during 2016’s rally and correction.

It’s worth noting the last two times it did this, gold advanced 18% and 13%, respectively.

With the Fed in a tricky situation regarding interest rates—and ambiguity likely to continue to surround the political arena—we may be in for a wild ride in 2017. Given the uncertain outlook and improving fundamentals for gold, now is a great time to add the yellow metal to your portfolio.

Gold is impervious to rust.
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