Gold Investing: What's Next After Recent Gold Price Highs?

Gold investing has become a hot topic on Wall Street these days. This is because gold prices (GOLD) recently hit new multi-month highs and are close to hitting new all-time highs. The yellow metal has been trending sharply higher since late September and is showing no signs of slowing down. 

Many investors get intimidated when they see an investment close to new all-time highs. But that's exactly what you want to see in a healthy bull market.

Monthly chart of the SPDR Gold Shares ETF (GLD)

"An object in motion tends to stay in motion," says Adam O'Dell, editor of Green Zone Fortunes, quoting Sir Isaac Newton. "While you can point to fundamental factors that support gold's rise, it's gold's price momentum itself that has my attention. Momentum buying tends to beget more momentum buying, and today I'm seeing the conditions in place for a significant move higher."

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Most gold is held in central bank vaults or held as jewelry, so the investable market for gold isn't exceptionally large. Take for instance these two gold ETFs: the SPDR Gold Shares (GLD) and the iShares Gold Trust (IAU). The former is the largest and most liquid gold ETF at $57 billion in assets under management (AUM), while the latter has just $28 billion in AUM. For perspective, the three largest S&P 500 Index ETFs have $1.5 trillion dollars in combined assets, and the market cap of the S&P 500 Index itself is $34 trillion.

So those worried about investing in gold at new highs, take a little heart. Given the relatively small size of the investable gold market, it wouldn't take much in the way of new inflows to send the price of gold sharply higher from here.

But why is gold trending higher, and can it continue?

Gold investing: Why is the gold price trending higher?

Inflation. The Fed flooded the capital markets with virtually unlimited liquidity for nearly two full years during the pandemic, expanding its balance sheet by almost $5 trillion in the process. 

This massive monetary stimulus – along with government assistance and a global supply chain that still isn't fully untangled – helped to push inflation to the highest levels in four decades. Consumer price index (CPI) inflation touched 9% in mid-2022 and remains high at over 6%.

Consumer price inflation since January 2018

Remember, gold is traditionally an inflation hedge. While its price is often volatile, gold has done a good job of maintaining purchasing power over the centuries. And while inflation is down from its highs, it is still a long way from the Fed's target of 2%. All else equal, high inflation bodes well for gold.

But gold's rise is not exclusively an inflation phenomenon. If that were the case, we wouldn't have seen gold prices weaken over the summer, when inflation was the highest. There's another element at play here.

The weak dollar

The U.S. dollar has been one of the world's stronger currencies over the past decade. The turmoil of the pandemic accelerated the dollar's rise, but that was only the beginning. As the Fed scaled back its asset purchases and started aggressively raising rates, the dollar soared to multi-decade highs against many world currencies, including the euro and British pound.

But since September, the dollar's strength has started to fade. The rest of the world's central banks are catching up in terms of monetary tightening, which has eliminated the primary driver of the dollar's torrid rise. You can see this in the performance of the Invesco DB US Dollar Index ETF (UUP), which tracks the performance of the dollar against a basket of major world currencies.

Monthly chart of the Invesco DB US Dollar Bullish ETF (UUP)

Gold's rise started the same time that the dollar's strength started to fade. That's no coincidence. Gold is priced in dollars, so dollar weakness is, by definition, gold strength.

The U.S. dollar has a history of trending higher versus other major world currencies for years or even decades at a time, but these periods of strength are generally followed by comparable stretches of dollar weakness. We may be in the early stages of one of those stretches … and that's bullish for gold.

Government dysfunction

Back in January, the United States officially hit its $31.4 trillion debt ceiling. In more normal times, Congress would simply raise the debt ceiling and life would go on. But these are not normal times, and as of the second week of February, we seemed to be no closer to a resolution. 

The House of Representatives is demanding spending cuts in exchange for raising the debt ceiling. But the White House is taking the view that Congress already approved the spending that this debt is needed to finance… and President Biden doesn't feel that this is the time or place for this discussion.

If no one blinks, the U.S. will likely default on its debts by early summer.

We've seen this movie before. The Republican-led House of Representatives and the Obama White House had a similar standoff back in late 2011. It was a little scary. And it resulted in the United States losing its AAA credit rating. Standard & Poor's cited political instability as its rationale for the downgrade.

Will the U.S. really default? Probably not. Our leaders are engaged in political theater, and no one really wants to see our nation's finances get shredded. But a crisis like this can also take on a life of its own, and even if we avoid default, we may see confidence in the dollar eroded by these shenanigans.

Under the circumstances, doesn't investing at least a little of your capital in gold make sense?

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