Gold Falls Below $1,300: What Led to the Plunge?

Gold suffered a decline of 1.84% on May 15, dropping below the psychological level of $1,300 an ounce. This was triggered by a rally in the U.S. dollar aided by a rise in U.S. Treasury yields, robust April U.S. retail sales and stronger-than-expected manufacturing data from the New York Federal Reserve. The yellow metal had last suffered such a drop in November 2016.

 

Rising Dollar, Treasury Yield Spell Doom for Gold Prices

 

The U.S. dollar received a boost from stronger-than-expected manufacturing data from the New York Federal Reserve. According to firms responding to the Empire State Manufacturing Survey dated May 2018, business activity grew strongly in NY. The Empire State Manufacturing index rose to a reading of 20.1 in May from 15.8 in April and also came well above the consensus forecast of 15.1.

 

The Empire State Manufacturing index rates the relative level of general business conditions in NY and the reading is compiled from a survey of about 200 manufacturers in the state. An increase was witnessed in new orders with the 16 reading in May, up from April’s reading of 9.

 

The dollar index versus a basket of currencies stood at 93.2 as 10-year Treasury yields surged to a seven-year peak of 3.095%. Latest upbeat retail sales data fueled speculations of U.S. Federal Reserve raising rates three more times this year. This prompted a spike the 10-year Treasury note. The 10-year yield is a barometer for mortgage rates and other financial instruments and thus important to investors.

 

Notably, yields and the dollar tend to move in tandem. Rising interest-rate expectations seems to have fueled the rise in yields. Further, reduced risk of a U.S.-China trade war helped bolster U.S. Treasury yields. Yields on U.S. government bonds have a strong inverse correlation to gold price as the metal produces no income and investors have to rely on price appreciation for returns.

 

The rise in bond yields signals that a June rate hike is imminent. This is likely to put gold prices under pressure. Also, with oil prices hitting a multi-year high above $70 a barrel, this is raising inflation fears in the market. The Federal Reserve could be forced to raise interest rates to keep inflation in check.

 

April Retail Sales Trigger Rate Hike Hopes: Negative for Gold

 

U.S. April retail sales rose by 0.3% month over month to $497.6 billion, matching expectations. March retail sales were revised to a gain of 0.8% from the previously reported rise of 0.6%. Out of 13 major retail categories, nine showed month-over-month increases. On a year-over-year basis, retail trade grew 4.7% in April, compared with a 4.9% rise in March.

 

These results add to the expectation that consumer spending, which is the single largest component of U.S. gross domestic product and considered as a gauge of the economy, has rebounded after a weak showing in the first quarter.

 

Notably, consumer spending grew at its slowest pace in the first quarter amid delays in processing tax refunds. Moreover, clean-up efforts following back-to-back hurricanes in late 2017 had led to forward spending in the fourth quarter.

 

A strong job market and higher take-home pay due to tax cuts has improved people’s spending power. This also acted as a shield against the pressure from costlier fuel that leaves people with less money to buy other goods and services.

 

The improvement in retail sales growth signals a strengthening economy and gives the Federal Reserve more reason to raise interest rates. Higher U.S. rates make gold a less attractive investment, as bullion does not offer interest. Consequently, an interest rate hike, possibly in June at the Fed's next meeting is likely to weigh on gold.

 

All is Not Over Yet

 

There are other factors that might support gold’s performance in 2018. A number of new mines entered production in fourth-quarter 2017, which might support mine production till 2018. On the demand side, major markets, India and its neighbor China, will continue to be growth drivers.

 

Last year, the Indian market had suffered a setback due to the impact of imposition of Good and Service Tax (“GST”) and anti-money laundering legislation (“AML”) around jewelry retail transactions. We expect it to bounce back as the market adapts to GST. Pent-up demand as well as festive buying is anticipated to boost demand for jewelry in the country.

 

Further, the second half of the year is seasonally strong for the country due to the festive and wedding season buying. Moreover, the United States continues to be a strong market driven by economic growth, improving employment levels and growth in consumer confidence. Also, increasing geopolitical tensions will support gold prices as it is sought as a store of value in these times.

 

Industry Positioning — Favorable

 

The Zacks Industry Rank relies on the same estimate revisions methodology that drives the Zacks Rank for stocks. The way to look at the complete list of industries is that, we put our X industries (all 265 of them) into two groups: the top half (i.e., industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank).

 

In the last 10 years, using a one week rebalance, the top half beat the bottom half by a factor of more than 2 to 1. Click here to know more: About Zacks Industry Rank

 

Within the Zacks Industry classification, Gold Mining industry with a Zacks Industry Rank of #101, remains in the top half.

 

We thus suggest investors to add stocks which are backed by a solid Zacks Rank such as AngloGold Ashanti Ltd. AU, Acacia Mining plc ABGLF and Alio Gold Inc. ALO. While AngloGold Ashanti sports a Zacks Rank #1 (Strong Buy), Acacia Mining and Alio Gold carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

 

Earnings estimates for AngloGold Ashanti have gone up 2% for fiscal 2018 and 1% for fiscal 2019, over the past 30 days. The Zacks Consensus Estimate for Acacia Mining has moved up 50% for fiscal 2018 and 13% for fiscal 2019. The earnings estimate for Alio Gold has moved up 7% for fiscal 2018.

 

However, we suggest steering clear of stocks such as Harmony Gold Mining Company Ltd. HMY and NovaGold Resources Inc. NG. These stocks has a Zacks Rank #4 (Sell) and have been witnessing negative revisions in their earnings estimates lately.

 

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