Will Gold Continue to Dwindle?

Despite the highly anticipated decision of the FOMC to start its third quantitative easing program, the price of gold hasn’t performed well during recent weeks. The ongoing debt crisis in Europe hasn’t helped precious metal prices. There are some concerns regarding the economic progress of China, among the leading countries in importing gold; the recent appreciation of the Indian Rupee may have also pulled back a bit the demand for gold in India, another leading country in importing gold. Despite the recent developments in Europe, China and India, the U.S will continue to be the main factor that could drive the price of gold up. Could the price of gold bounce back or will it further dwindle slowly throughout the rest of the year?

One of the main factors that could have adversely affected the price of gold was the anticlimax that came soon after the FOMC made its decision to launch QE3. There are some who think that QE3 won’t have an adverse effect on the value of the USD. After all, despite the launch of QE1 (back in 2008) and QE2 (back in 2010), the value of the USD hasn’t crashed against other leading countries’ currencies and the U.S inflation sans energy and food hasn’t risen above the Federal Reserve’s target inflation. According to the recent U.S CPI report the core CPI (excluding energy and food prices) rose by only 2% during the past 12 months. This could be among the reasons to curb the demand for gold as a safe haven against the potential crash of the USD.

Will the Fed Intervene in the Markets Again?

There are some signs of progress in the U.S economy: the U.S non-farm payroll report presented a sharp drop in the unemployment rate and the number of jobs added was also higher than expected. The U.S retail sales increased by 1.1% in September, which was also higher rate than many had expected. This news may have lowered the chances of the FOMC introducing additional stimulus plans in the next FOMC meeting (to be held during October 23-24). Nonetheless, next week’s FOMC meeting could affect the price of gold. If the Fed will suggest of additional plans to jump-start the U.S economy this could help rally the price gold. My guess, however, is that the Fed will keep its policy unchanged for now.

Since September 14th, following the FOMC decision to launch QE3, not only the price of gold hasn’t performed well, but also stocks of gold producers such as Barrick Gold Corporation (NYSE: ABX)  and Royal Gold, Inc. (NASDAQ: RGLD) haven’t done much. The chart below shows the developments of these stocks, the price of gold and the S&P500. As seen, the major gold producers, much like the price of gold, haven’t performed well in recent weeks.

There is a strong and positive correlation between the changes of the gold producers’ stocks and the price of gold: during September and October the linear correlation between Royal Gold and gold was 0.49. This means, that under certain assumptions the changes in the price of gold could explain nearly 25% of the volatility of the Royal Gold’s stock. During September and October, the linear correlation between Barrick and the price of gold was 0.69. These figures suggest that if gold won’t rise, shares of major gold producers won’t perform well.gold and snp500 and royal gold

At least, holders of gold producers stocks, as oppose to holders of gold, receive dividend: currently, Barrick offers a quarterly dividend of $0.2 which is nearly 2.01% yearly yield; Royal Gold offers a quarterly dividend of $0.15 which is nearly 0.67% yearly yield.

The ongoing stagnation in the price of gold and by extension gold producers may continue unless the Fed will surprise and introduce an additional stimulus plan. Since the recent U.S reports showed some signs of recovery, they lower the chances of the Fed making another move next week. Therefore, I suspect gold and the major gold producer will remain at their current price range in the weeks to follow.

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