The gold price is down more than 15 per cent from the high of Jan. 22, 2015, and 43 per cent from the postcrisis high in September, 2011. Sentiment is depressed, and the most ardent precious metals fans are likely considering throwing in the towel. Contrarian investors, however, are drawn to market pessimism and inclined to look for bargains in downtrodden sectors.
Is it time to buy gold? This week's charts look at the best leading indicators of the gold price in search of the answer.
Stéfane Marion, chief economist at National Bank, writes that for bullion prices, "the U.S. dollar, real interest rates [10-year Treasury Inflation Protected Securities], … financial stress [CBOE volatility index] and inflation [we use the United Nations food price index as a proxy] are the most powerful drivers."
I tested all of these indicators over the past five and 10 years and found one big surprise – the value of the U.S. trade-weighted dollar index has not been closely associated with price changes in gold. One of the primary advantages of precious metals investing is to protect against inflation's negative effects on the spending power of the greenback. A closer relationship was expected.
Real (inflation-adjusted) U.S. interest rates have been the second-best indicator for gold in the past five years. It is an inverse relationship – gold falls as real interest rates rise – so rates are plotted inversely on the first chart, below.
For investors looking for a leading indicator for the price of bullion, the problem is the period on the chart from the end of October, 2012, to June, 2014. It appears that the gold price predicted the rise in real yields (reminder – the yields are plotted inversely), rather than the other way around.
Global inflation levels as measured by the UN food price index (lower chart) has provided the most accurate signs for gold over the long term. This was another surprise, but maybe it shouldn't have been. The TIPs and gold relationship only encompasses conditions in the United States, but the world's largest buyers of gold are outside of country. Russia and Kazakhstan were the biggest buyers of bullion in 2014, according to the World Gold Council.
Unlike real yields, global food prices also appear to offer forward-looking signs on the gold price. This was particularly true in early 2011 when the index began reflecting declining inflation pressure worldwide.
Neither of these two indicators suggest that even contrarian investors are ready to step into the gold market. We did, however, learn of a new effective leading indicator for gold prices. When the global food price index turns up finally, a bottom may be approaching for the gold price.
Scott Barlow, Globe Investor's in-house market strategist, writes exclusively for our subscribers at Inside the Market online.