On various occasions, I have pointed out the fact that the gold price often depends on returns elsewhere on capital markets. In other words, the return on gold heavily depends on interest rates on credit markets and returns on stock markets. For the moment, stock market returns are historically high: the most important stock market indexes in the US (the NASDAQ, Dow Jones and S&P 500) are currently returning somewhere between ten and twenty percent on a year-to-year basis.

At the same time, interest rates are rising on credit markets. Or to be more precise: the Federal Reserve has initiated a series of interest rate hikes. The market currently prices in one more rate hike in December (the odds of a rate hike in December stand at roughly seventy percent, which is something we can derive from the futures market). In short, interest rates are on the rise, at least in the United States. Meanwhile, inflation remains subdued. The latest inflation figures show that inflation is still positive but has nevertheless been slowing down in recent months.

In summary, real returns (corrected for inflation) on credit and capital markets are high. And the higher the returns on capital markets, the lower the return on gold.

Below, for instance, you can observe a chart of daily gold prices in dollars (left axis) and the real 5-year US Treasury interest rate, but then inversed (right axis). We can conclude that the correlation between these two variables is close to perfect.

The real 5-year US Treasury rate is simply the 5-year US Treasury rate corrected for (the future expectations for) inflation, and then I inverted that rate.

In 2014, the dollar embarked upon a great upturn. Coincidentally, or perhaps logically, gold prices suffered greatly during this dollar rally. Nevertheless, the dollar has suffered from a recent correction. The euro/dollar rate, for example, rose from 1.04 to almost 1.21. At the same time, gold prices (measured in dollars) rose to the same extent. In other words, perhaps it was not the gold prices that moved, but rather the dollar.

Since a month ago, however, the dollar seems to have resumed its rally, something which I wrote about in an earlier piece. The dollar strengthened momentarily from 1.21 to 1.17. It now appears as if all signs have turned green for the dollar. This would mean that the gold price is expected to have a tough last quarter this year.

Yet not everyone agrees with me. John Reade, the Chief Market Strategist of the World Gold Council, argued in an interview with the Financial Times that the recent strengthening of the dollar is no sign of the dollar resuming its rally. According to Reade, the recent rebound of the dollar is in no way indicative of a renewed dollar bull market which began in 2014. “The dollar bull market has lasted a long time and gone quite a way,” Reade remarks in the Financial Times. “The rest of the world will follow suit on rate hikes so maybe we’re in for a period of dollar weakness for the next few years.”

According to my judgment, Reade is wrong on two accounts:

1. Rate hikes in the “rest of the world” will have to wait
   The “rest of the world”, which we can loosely define as the European Central Bank (ECB) and the Bank of Japan (BoJ), will most certainly not raise interest rates anytime soon. Better yet, it might be years before these central banks will only consider a rate hike. The ECB will first have to taper its large-scale asset purchase program, which will be extremely gradual, and will only then, after a long period of pondering, decide to raise interest rates. The Bank of Japan finds itself in more or less the same situation. There seems to be no reason for the heads of the Japanese central bank to only consider raising interest rates in the short term.
    
2. Relatively high odds of a recession
   John Reade also seems to forget the possibility that the US economy enters into a recession in the period which he is trying to foresee. And the dollar is still the world´s preferred safe haven. When the US economy falls into recession again, the dollar will strengthen, whatever interest rates are. As we have concluded before, and on the basis of various indicators, we are due for a recession since some time now. Next week I will show, for instance, that the yield curve is flattening even further, which might be a sign that a recession is approaching. In this case, a dollar rally could easily push the euro/dollar rate to parity (in which 1 euro equals 1 dollar).

Gold prices might remain under pressure until at least the end of the year.

I suspect that the dollar rally will resume and that therefore gold prices remain in a tough situation. In that case, gold prices will remain under pressure, as long as the current narrative remains dominant across market participants (the current dominant narrative can be summarized as: “the Fed is raising interest rates”). Only when this dominant paradigm, this narrative, suffers a terrible blow for whatever reason, a real reversal might happen in the gold market. Whatever the case, gold seems relatively cheap, especially in comparison to the existing alternatives (mainly bonds and shares). Therefore, the advice seems still to gradually accumulate a significant position in (physical) gold.

Do not forget: returns are earned in the long run, but in very brief periods, which as a general rule we are completely unable to predict. The only thing we can do as investors is to decide which investments are “cheap” and which are “expensive,” without pretending that we have a crystal and capable of predicting which investment will rise or fall in a given time frame.