Will GLD Resume Its Decline?

Even though shares of SPDR Gold Trust (NYSEARCA:GLD) were up for August, they are still down for the year. The debate over the Federal Reserve’s rate hike continues. The devaluation of the Chinese yuan along with low inflation and the strong U.S. dollar reduce the odds of a rate hike in September. But the Fed keeps us guessing. Nonetheless, a stronger than expected non-farm payroll report could bring back up the probability of a September hike and drag back down the price of GLD. Let’s see the recent developments in the market and their relation to GLD.

The market still doesn’t know when the Fed will be ready to hit liftoff. And although the implied probabilities for a September rate hike are still very low – the odds are only 28% in September and 56% in December, the market could still raise these odds again if the upcoming non-farm payroll report exceeds the market’s expectations. Currently, the market expects a gain of around 220,000 jobs; if the actual number comes at over 250,000 this may be enough to rekindle the possibility of a rate hike later this month. Back in July, the NFP report showed a gain of 215,000, slightly below expectations, which still led to a rise in the price of GLD.

When it comes to the September rate hike, even Federal Reserve Vice Chair Stanley Fischer, in a recent interview, still refrained from voicing his opinion about the September meeting and kept the possibility of a hike on the table. He was also optimistic in Jackson Hole and thinks inflation will pick up:

“Given the apparent stability of inflation expectations, there is good reason to believe that inflation will move higher as the forces holding down inflation dissipate further.”

If this is the case, it will be harder for the Fed to reach its goal of 2% as rates start to rise again. Also, inflation aren’t, for now, rising.

Moreover, the ongoing descent in the core CPI may have also contributed to the weakness of gold in the past couple of years. The chart below presents the price of gold and annual percent changes in core PCE between 2011 and 2015.

Source:FRED

The combination of a stronger dollar, which is likely to further strengthen as the Fed begins normalization, along with the low price environment, driven, in part, by falling commodities prices, isn’t expected to help gold or the price of GLD to bounce back from its recent fall.

It’s also worth noting, a point made on CNBC, that the current long-term yields are still low – the 10-year Treasury bond yields are around 2.2%. Back when the Fed started to raise rates, yields were much higher – the spread between the federal funds rate and the 10-year note was closer to 4%. Thus, the market conditions, at least from the bond market, aren’t best for a rate hike.

I think it’s not likely that the Fed will raise rates – for the same reasons everyone states including China, low inflation and yields, global economic uncertainty, strong U.S. dollar and more – any time soon. But we should also remember the Fed is purposefully avoiding from giving clearer guidance and keeping us guessing: It’s trying to test the waters and see the market’s reactions. So far, the growth in the U.S., which was very strong in Q2, could still change course. The labor market is improving but still has room for improvement especially when it comes to wages. And most importantly, inflation is low and higher rates won’t bring it any faster to the Fed’s target.

For GLD, low inflation and the strong U.S. dollar will drag its shares down. Conversely, economic uncertainty could play in favor for its price – as was the case back in mid-August. Thus, over the short term, we could still see modest gains in the price of GLD, but as long as the Fed heads towards normalization – if not in September then in December or the beginning of 2016 – the U.S. dollar is, for the most part, heading up, GLD is likely to resume its slow descent. Source