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Time to Buy Gold ETFs on the Dip?

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Gold prices are declining due to increased odds of a Fed rate hike in March. Thanks to a 44-year low U.S. jobless claims signaling a solid labor market and a considerable pickup in inflation, 10-year high existing home sales and a recent recoil in retail sales pointed to nothing but an imminent rate hike (read: January Chills Warm Gold ETFs: How Long Will the Shine Last?).

Meanwhile, factory activity expanded in February at the fastest pace since August 2014 on strengthening orders and production. The ISM index jumped to 57.7, maintaining the march for six months in a row, from 56 a month earlier.

If this was not enough, Fed Governor Lael Brainard – who was a strong proponent of easy money policy before – also signaled a sooner-than-expected tightening saying, “it will likely be appropriate soon to remove additional accommodation.”

A few other Fed officials including Dudley, Williams, Kaplan and Harker have also been singing in the same tune. With this, chances of a March rate hike increased to 69% as per CME while some other market gauges claim that it is as high as 80%.

This added fuel to the greenback leading PowerShares DB US Dollar Bullish ETF UUP to add over 0.4% on March 3. As a result, yield on the 10-year U.S. Treasury note increased 13 bps to 2.49% in the last two days (as of March 2, 2017).

Gold ETFs Under Pressure

As a result, the optimism surrounding gold investing, which bears no interest, has started to drain. The largest gold bullion ETF SPDR Gold Shares GLD lost about 1.24% on March 2 while gold mining ETFs like VanEck Vectors Gold Miners ETF GDX shed 4.6% on the same day. The latter put up with more losses because mining products are normally viewed as leveraged plays to the underlying metal (see all precious metal ETFs here).

VanEck Vectors Junior Gold Miners ETFGDXJ was off 8.2% on March 2, iShares MSCI Global Gold Miners (RING - Free Report) shed 4.6% and Sprott Gold Miners ETF SGDM plunged about 5% on March 2. In a nutshell, gold investments, especially the miners turned to dust on March 2 (read: Profit Out of Bleeding Gold Mining ETFs).

Note that gold bullion trades at over $1,200 level at the time of writing. In the recent past, we saw gold slipping below $1,100 an ounce several times on Fed hike worries.

Will Gold Be This Battered for Long?

First of all, whenever gold lost its glitter due to rate hike prospects, it snapped back soon on most occasions on broader market sell-off. This time, chances of a rebound in gold are higher given the overvaluation concerns in the equity market thanks to an amazing Trump rally.

Note that the forward price-earnings (P/E) ratio for the S&P 500 companies now stands at around 17.6x – the highest since June 2004, higher than the 5-year and 10-year averages of 15x and 14x, respectively, as per the source.

If the Fed hikes faster this year, there will likely be slight upheavals in equities, no matter how strong the impact of Trump’s fiscal reflation is on equities. This opens up room for outperformance in gold prices. Investors view gold as a safe haven asset.

Apart from a possible equity market correction, factors like considerably high household debt in a rising rate environment and a series of elections lined up in Europe in the near-to-medium term can trigger significant volatility in the coming days (read: January Chills Warm Gold ETFs: How Long Will the Shine Last?).

A pickup in inflationis another friend of gold. The metal is often viewed as a hedge against inflation. One of the pre-requisites of the Fed hike is higher inflation. So, if the Fed makes faster moves going forward, there has to be some noticeable uptick in inflation, which in turn is likely to boost demand for inflation-protected assets like gold.

Gold demand in one of its key-consuming market – India – is picking up steam, for the first time in about a year. India’s gold imports skyrocketed 82% in February following a slack 2016. Cash crunch issues on demonetization are now ebbing (read: 5 Reasons Why Gold ETFs Can Regain Their Mojo).

Bottom Line

All in all, gold may win ahead with rock-bottom interest rates prevailing in most corners of the developed world. Even if the Fed raises rates faster this year, the hike should not be aggressive enough to push the economy back to a recession again.

The recent dip in gold prices also steers clear of overvaluation concerns in gold, giving it a fresh reason to run. In a nutshell, gold is likely to inch up in the coming days, though at a slower pace. Fed rate hike possibility and Trump’s promise of fiscal reflation are possibly priced in at the current level.

Note that, hedge funds and money managers raised their net long position in COMEX gold to the highest in more than three months in the week ended February 28. Still, investors intending to play gold’s dive on a short-term basis can tap inverse ETFs like UltraShort Gold ETF GLL), DB Gold Double Short ETN DZZ and Power Shares DB Gold Short ETN DGZ.

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