Is Gold On Its Last Legs?

David Goodboy's picture

Monday, October 24, 2016 - 11:30am

by David Goodboy

I am about to make a bold call on the future price of gold. Clearly, no one knows the future, but I firmly think that the preponderance of the evidence points toward dramatically lower prices for the yellow metal over the next 24 months. In fact, I expect gold prices to drop below $1,000 per ounce by October 2018. In other words, it is time to take profits now. First, let's take a brief look at gold  itself.

Gold has enamored investors since the dawn of time. Economists and merchants alike have long spoken of the yellow metal's value, stability, and longevity throughout the ages. Entire economies, including the United States, have linked their currency at a fixed rate to the price of gold. Known as the gold standard, this pricing mechanism was completely abandoned in the United States in 1971 when President Richard Nixon made the decision to let the U.S. Dollar and gold float independently of one another.  

Since that time, gold prices have fluctuated widely, hitting an all-time high of $1,924 per oz in the summer of 2011. Investors who rode this wave to the top made fortunes with the precious metal. However, despite the assurances of the gold bugs, gold failed ever to push beyond the 2011 highs.

The price dropped back immediately, struggled to form a double top technical formation on the monthly chart, then spent the next three years moving solidly lower. Prices found a bottom near $1,050 per oz during the final few months of 2015, then took off on the upside. It found resistance again close to $1,375 per oz in July, advancing a full 30% in just a short six months before retreating back into the $1,250 per oz region.  
 

I don't think this is the end of gold's drop. I fully expect gold prices to continue their descent and drop below the previous low of $1,050 within the next 24 months. Here's why:

A Strong Dollar Pushes Gold Down
After what seems like an economic eternity, interest rates will most likely be moving higher. Federal Funds Futures indicate a 70% chance of a rate increase by the end of 2016. If rates fail to be increased in 2016, inflation and employment numbers will most certainly force the ramp higher into 2017.  Why is this relevant to the price of gold?

The reason is that gold price is denominated in U.S. dollars. As interest rates climb, the greenback becomes stronger. A stronger U.S. dollar has an inverse effect on the price of gold.  This also makes gold less attractive to non-U.S. investors, resulting in less demand and lower prices.

The International Monetary Fund conducted a study in 2008 revealing that approximately 40% to 50% of gold price changes since 2002 could be attributed to moves in the U.S. dollar. The study went on to state that every 1% change in the practical external value of the greenback resulted in a greater than 1% move in the price of gold.

Interest rates have nowhere else to go but higher right now.  The resulting stronger U.S. dollar will pressure gold prices lower.

China's Continued Growth Reduces Gold Demand
Fears of a hard landing or crash in China's economy have largely diminished. The resulting decrease in global volatility has resulted in less demand for safe haven assets such as gold.  

According to The Financial Express in Bangladesh, China's economy performed better than expected in the third quarter and the country's debt risks are under control. Premier Li Keqiang stated, 
"China's economy in the third quarter not only extended growth momentum in the first half but showed many positive changes."

At the same time, this move away from gold creates greater demand for income producing assets.

The Smart Money's Getting Out
The Commitment of Traders, or COT, report revealed that large future traders and speculators had reduced their net bullish positions to the lowest levels since June during the first week of October. In other words, the smart money is drastically slashing their exposure to the precious metal.

Gold May Even Become Obsolete
The world is embracing new ways to create and transfer value. Ancient stores of value, such as gold, are quickly being made irrelevant by technology. One technology in particular, Blockchain, is the manifestation of high-tech creating its own means of value transfer from one user to the next.

The Wall Street Journal defines blockchain as " a data structure that makes it possible to create a digital ledger of transactions and share it among a distributed network of computers. It uses cryptography to allow each participant on the network to manipulate the ledger in a secure way without the need for a central authority."

In other words, the technology eliminates the need for a central authority to confirm trust between users, which changes the power matrix from large institutions and governments to the individual and small groups. The structure of blockchain transactions makes it unnecessary to even know whom you are dealing with when conducting commerce, and still have full trust in the transaction itself.  

Advanced algorithms are used to verify and confirm transactions, thereby creating a historical record. Bitcoin, for example, is a virtual currency that uses a blockchain platform.  

Blockchain technology is still in its infancy, lacking a fully realized application and having only a minor overall economic effect. However, its existence may signify that gold is on its way to becoming irrelevant in the future economic reality.  

Risks To Consider: The unknown factor in any gold price analysis is the risk of geopolitical tensions increasing.  A sharp increase in global fear levels will likely result in increased buying of safe haven assets such as precious metals.  

Action to Take: Sell your gold holdings now.  

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David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.