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Gold's 2016 Rally: Don't Fall for the "Fear Trade"

By Alex Dumortier, CFA – Feb 22, 2016 at 12:35PM

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Gold has performed well in 2016 as fears of systemic failure increased. That's no reason to put on this "fear trade."

Is the fear that sent global markets lower this year beginning to subside for good? Today, it's "risk on" mode as the Dow Jones Industrial Average (^DJI -0.43%) joins the S&P 500 (^GSPC -0.21%) in climbing out of correction territory (a correction is usually defined as a 10% pull-back from the high). The Dow and the S&P 500 are up 1.31% and 1.28%, respectively, at 12:29 p.m. ET.

Traders may be taking their cues from the oil market, with the active Brent crude futures up 5.57% at 12:29 p.m. ET. One commodity that isn't faring well today is gold; the most popular gold ETF, the SPDR Gold Shares (NYSEMKT: GLD) is losing 1.57% as of this writing.


Don't fall for gold's luster.

With very few industrial applications, gold doesn't trade like a genuine commodity. You might be better served to think of it as psychological commodity, one that provides comfort to the anxious, the unhinged, and those more or less rational individuals who have fallen for gold marketers' pitch.

Driven by sentiment -- mainly fear -- gold has performed well this year, as traders have fled risk assets out of fear of...well, pick your favorite or any combination of flavors from among the following:

  • Instability of the Chinese financial system, including the yuan (the theme of a "hard landing" of the Chinese economy is a bit played out at this stage).
  • Central bankers' inability to spur adequate self-sustaining growth in developed economies.
  • Deflation, or disinflation, at the very least (see previous point).
  • Negative interest rates, as monetary experimentation continues in Japan, the European Central Bank, and elsewhere.
  • Continued volatility in the price of oil and the adjustment to a "lower for longer" price perspective.
  • Concerns about the health of "too big to fail" banks' balance sheets.
  • (Insert your favorite fear here.)

In the years following of the financial crisis, we have repeatedly heard journalists, professional investors and other assorted experts say that we are in a period of "increased uncertainty" or "exceptional uncertainty." I'm guilty of saying that myself. But if you pause for just a moment, you may begin to see how absurd that notion is.

First, is there some objective measure of this uncertainty that nobody has told me about? (If you answered the CBOE Volatility Index (VOLATILITYINDICES: ^VIX), it doesn't qualify -- I'll explain why in just a moment.)

Second, when has the future been anything other than uncertain?

What people typically mean when they say "uncertainty has increased" is: "Objectively, things haven't changed much, but my awareness of and sensitivity to the always inherent uncertainty of the world has suddenly increased, and so has that of many other market participants." The awareness of uncertainty is mainly what an index like the VIX measures.

The price of gold will ebb and flow with these shifts in awareness, but the rally that gold has enjoyed this year has, in all likelihood, run out of steam. Led by Jeffrey Currie, the commodities research team at Goldman Sachs last week published a note in which they forecast that gold would fall back to $1,100 per ounce in three months, and drop to $1,000 in 12 months.

In the note, titled "Nothing to fear but fear itself," the analysts wrote "We believe that these new [macro] fears, like past fears, are not justified," adding that "[s]ystemic risks stemming from the collapse in oil and commodity prices are extremely small."

They're almost certainty right -- don't fall for the "fear trade."

Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Dow Jones Industrial Average (Price Return) Stock Quote
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