I’m not wildly excited about gold in 2017 – but I just can’t be bearish

So today we turn our attention to the alluring, the lustrous, the irresistible metal that is gold.

What next?

Up? Down? Sideways?

What really matters for gold – and everything else – this year

As a UK-based gold owner, let me say I’m not wildly bullish about gold’s prospects in the near term. But nor am I wildly bearish.

I’ll explain first why I’m not wildly bullish using just one word: sterling.

2016 was the year to own gold. It began the year around £720 an ounce, and ended it around £940 – a 30% gain. Gold had an OK year anyway – up around 8% in US dollars – but it was a bonanza year for UK investors for the simple reason that sterling was so weak.

I’m of the view that sterling has some upside now and sterling strength – if we see it – limits gold’s potential upside. Of course, if you’re a sterling bear, then back up the truck and load it up with gold (and don’t tell anyone where you’re taking it).

However, the really big question – and this is not just the elephant in the investment room, but the dinosaur – is where does the US dollar go from here?

It’s easy to find both bullish and bearish arguments.

Dollar bears can argue: “President Trump wants the dollar to go lower. He needs it to go lower to allow for his plans to spend more and tax less. So he and his team will engineer it lower.”

Dollar bulls can reply: “Everyone is trying to engineer their currency lower. America is great. America is strong. The US dollar goes higher.”

The trend since May 2016 has been up. But the trend this year has been down. Take your pick.

Whatever your view, the dollar is key. From the US dollar, we learn whether next we see inflation raising its head again – a real possibility – or whether the deflationary forces at play continue to win out.

Dollar strength will impact global trade and capital flows. There’s a relationship between a strong dollar and interest rates.

All of the above will affect the price of gold.

For now I’m inclined to favour the current, short-term trend in gold – which is up. $1,240 is possible, maybe even $1,310. But it wouldn’t surprise me if 2017 turned out to be year of range trading, rather than a full-blown bull or bear market.

Below is a one-year chart for your reference.

Gold price chart

But if the pound strengthens too, gold’s gains in sterling won’t be so pronounced.

Why I find it hard to be bearish on gold

The reason I am not wildly bearish, apart from the fact that the short-term trends are mostly up, is this developing narrative of civil division and unrest. It has been brewing for many years now. In fact, I don’t think it’s unreasonable to say it’s been brewing for half a generation.

There were the loose monetary policies and easy credit of the Brown-Blair years and the house-price boom. There was the gap between the actions of elected leaders and what ordinary people actually wanted; between the riches of the super-rich versus normal people.

Frustration grew with perceived inequality – income inequality, wealth inequality, inequality of opportunity. The credit bust of 2008 and the subsequent policy reaction only made matters worse. A very real belief has emerged that the playing field is not level.

That nobody can agree on the answer is exacerbating the division. For some, capitalism is the problem; for others, it is the solution. For some, the state is the problem; for others, it is the solution.

In 2016 the feeling was that the saucepan is boiling over. First there was Brexit; then there was Trump. While joyous for some, the reaction of the losing side has not been to stoically accept the result. It has been to fight by every means possible – whether to march, to debate, to protest, to undermine via legal barrier or bureaucratic process, in some cases even to resort to violence.

My questions to you are: was Brexit the end of it, or is this civil division and unrest going to grow? Will the American left resignedly accept Trump now, or will they continue to try and bring him down? If they do bring him down – let’s say they find a way of impeaching him – then how will his supporters react? If Brexit is somehow blocked (it doesn’t look likely, but you never know), then what will be the reaction of the 52%?

In short, across the developed world, is civil tension, unrest and division going to bubble over, or is it going to simmer down in the coming years?

I can envisage both scenarios. I can see a resigned acceptance to both Brexit and Trump. But I can also see a growing anger. Perhaps, say, Brexit is not managed properly. Or Trump is found out by some monster gaffe. Perhaps there is some fall-out from the French and German votes later this year.

The biggest bone of economic contention in the UK

I would argue that the single biggest cause of discontent in Britain is the broken housing market: the simple matter of who owns a house and who doesn’t. Most people would like to own a house. Houses don’t cost a lot of money to build. There is no shortage of land.

Yet there is a shortage of affordable housing in areas where people want to live. Others meanwhile have been handed a fortune on a plate without having done anything to earn it.

One solution is much lower prices. But homeowners won’t want that, and the deflationary consequences of a housing bust, whether needed or not, would be a problem, to say the least.

The second solution is dramatically higher earnings – AKA inflation, which also has problematic consequences. The third solution (and it’s not really worthy of the name) is the current stand-off, which just means more frustration and unrest.

There is every chance that this narrative of civil discontent, division and unrest continues to fester and worsen in the coming years, even if there are no big, catalytic votes coming up in the US and UK. That’s why I’m not particularly bearish about gold.

  • You assume that sterling is the reference level. Sterling may well perform better than gold, and foreign goods will become cheaper. But even sterling is a currency bet.

    I agree with your brief analysis on housing. My own view is that the wealth inequality, which really means land inequality in the UK, is best alleviated with a Land Value Tax. Apart from anything else, the land ultimately belongs to the nation – all of us – and its owners are there because we let them be there!!!

    • Michael T

      Doesn’t LVT simply alter the reason as to why someone can’t afford to live in a particular house? As of now the reason would be because the house was too expensive to purchase, and after introducing LVT the reason would be because the LVT was not affordable?

      Is the desired effect of LVT to devalue the property? I.e. the wealth that a person had from the value of the property is effectively “wiped out”(?)

      • Ben Jamin’

        The only reason land has a monetary value is because its scarcity value is unevenly distributed. So via rents and selling prices we get a pure transfer payment from one group in society to another. This is why affordability issues and excessive individual/regional/inter-generational inequality are two sides of the same coin.

        So not only would an LVT reduce the selling price of housing to its capital only constituent, it would considerably boost the disposable incomes for most people in the UK.

        Housing affordability, as measured by ratio of discretionary incomes, improves by a factor of four for a typical UK household.

        The desire is to reduce costs and inequality.

        While building more houses may marginally reduce selling prices, it will do so by adding to costs. An LVT not only reduces selling prices more effectively, but by rationalizing existing housing, reduces costs.

        • AAJ

          Would this also help with the unoccupied investment flats in London? We keep building flats that are not used for people to live in and this doesn’t appear to benefit anyone other than the original builder.

          • Ben Jamin’

            The UK has a million more homes than households and 25 million empty bedrooms. We don’t have a shortage. An allocation problem, yes.

            More importantly, the disposable incomes of typical households are reduced by tens of thousands of pounds because we choose to tax those that produce goods and services, instead of those that own valuable locations.

  • rory

    I really wish advocates of LVT would actually read Adam Smith and try to understand why it was an appropriate suggestion 250 yrs ago but isn’t now. We have an entirely appropriate substitute in CGT. Problem is CGT isn’t charged on most of the most valuable and fastest appreciating land in the country. I.e. the land beneath our residential housing.

  • Thanks Dominic – your headline makes it sound as if you are slightly ambivalent when I think actually it is – like the politics you describe – much polarised. There are some epic things afoot including deep inflation, and Shariah compliant gold likely to give the market a substantial boost – while deep falls in demand in key markets including India, China and among Central Banks possibly indicating a serious decline. You might say these could all offset each other but I suspect they won’t. As year of the Rooster suggests – expect some volatility.

  • dfjkbvdjkf

    So what happens when QE stops and yields (at last!) begin to rise?
    The only reason gold soared so high, post-2008 is because all other investment vehicles gave such poor returns. If we can see a return to sensible, positive, returns then gold starts to lose its attraction.