Gold opened 2016 at $1082 per ounce, based on the London PM Fix, and this price rose to $1226 by February 26, 2016. The SPDR Gold Trust ETF (NYSEARCA: GLD) entered 2016 at $101.46, rising 17% to $118.76 by the end of February. In the first two months of 2016, the gold rally was supported primarily by instability in the global economy, while interest rates and inflation expectations provided the necessary conditions for gold to become the destination for capital. Analyst expectations for gold over the final three quarters of 2016 were mixed after the rally, but most forecasts called for losses or modest gains in gold prices. The Federal Reserve is expected to slowly continue its rate hikes, and disinflationary pressures remain strong globally. With stabilization in major equity markets, the major catalysts driving gold higher seem to be abating.
Uncertainty
Gold is generally used as a hedge in portfolios, protecting against risks associated with adverse monetary, fiscal or macroeconomic conditions. Investors have historically flocked to gold in times of uncertainty or instability, due largely to the metal's insulation from industrial production growth and its traditional use as physical currency. In the first two months of 2016, substantial uncertainty loomed over the global economy. Ominous signs out of the Chinese economy triggered steep declines in the Shanghai Stock Exchange. Low energy and commodity prices continued to drag on heavily extractive economies.
South American countries such as Brazil and Argentina experienced turmoil and high inflation, with Brazil enduring sustained gross domestic product (GDP) contraction. High unemployment and low capacity utilization in Europe compounded the fiscal problems emerging in the region, and concerns grew that monetary policy lacked the efficacy required to promote growth. Sharp commodity price declines and rumblings over a possible recession amid lukewarm corporate earnings and guidance took a toll on US. equities.
This complex set of circumstances left investors with uninspiring options, with clear risks attached to different asset classes in many of the popular global markets. Given gold's traditional role as a hedge in portfolios, demand was stimulated by fear entering investor sentiment. The gold rally of early 2016 was supported primarily by trepidation and uncertainty surrounding other assets.
Low Opportunity Cost
With uncertainty gripping global markets, low inflation rates helped exacerbate the flow of capital toward gold and related securities. As capital flowed out of stocks in China, the United States and Europe, low interest rates around the globe dampened demand for government debt securities. Early in 2016, interest rates remained at low levels after years of expansionary monetary policy. While the Federal Reserve announced intentions to slowly raise rates, other central banks were forced to cut further rates or otherwise forgo normalization. The Bank of Japan and the European Central Bank both pushed nominal interest rates into negative territory, which is a relatively extreme measure.
Falling equity prices and pressure from finance ministers around the world caused many to speculate that the Fed's normalization program would decelerate. Gold prices tend to plunge as the opportunity cost of holding gold rises, with high interest rates or equity appreciation coaxing investors from the perceived safety of gold assets. In 2016, low interest rates inhibited this effect, combining with fears over global equity fundamentals to push investors toward gold.
Inflation
When currencies falter, gold is often considered a natural store of value, and prices typically have an inverse relationship with currency strength. As inflation expectations rise, especially those of the US. dollar, gold prices usually rise as well. Global inflation has been sluggish, and the consensus outlook calls for modest inflation acceleration in coming years.
High unemployment and low capacity utilization have created disinflationary pressures in Europe, while the Bank of Japan was forced to offer negative interest rates in an effort to stimulate inflation. Nonetheless, core inflation in the US., which controls for the effects of food and energy prices, has increased steadily in recent months. Falling expectations for Federal Reserve rate hikes contributed to rising inflation expectations. Global inflation rates will likely not be high enough in 2016 to cause a sustained gold rally, but expectations were adjusted enough in January and February to allow other factors to push gold higher.
