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The curse has been lifted, for now at least. After putting in three consecutive losing years following more than a decade-long streak of gains, gold regained its luster in 2016 with a 9% year-over-year increase. Of course, gold's gains were considerably higher earlier in the year, with the precious yellow metal nearly hitting $1,400 per ounce from a 2016 low of $1,050 ounce. As we begin 2017, gold will be looking to build upon its $1,151 per ounce starting point.
Gold's biggest catalysts in 2017
However, Wall Street and investors have little time to dwell on the past, no matter how much they might enjoy seeing assets increase in value. With 2016 now in the books, it's time to turn to 2017 and examine what catalysts could be moving the gold market this year. In no particular order, I'd suggest physical gold and gold mining stock investors pay close attention to the following three market movers.
The Federal Reserve
It probably comes as little shock that the leading catalyst for physical gold in 2017 is likely to come down to what the Federal Reserve does with interest rates.
As a quick refresher, physical gold has no dividend. On the other hand, interest-bearing assets such as a savings account, bank CD, or U.S. Treasury bond do have near-guaranteed nominal return rates. In recent years, with the Fed keepings its benchmark federal funds rate near a historic low, the nominal returns on these interest-bearing assets were often lower than the national inflation rate. In layman's terms, it means that even though investors were netting a positive nominal return from buying a CD or Treasury bond, they were still losing real money because of inflation outpacing their gains. In this scenario, the opportunity cost of giving up the near-guaranteed gain in order to buy gold, which may or may not offer the chance of a greater return, is low. A low opportunity cost favors strength in gold prices.
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However, the Fed has raised its benchmark rate twice over the past 13 months. Though its federal funds target rate is still historically very low, the nominal returns on interest-bearing assets is beginning to rise, increasing the opportunity cost of forgoing these near-guaranteed returns in exchange for owning gold. If rates were to continue rising, the demand for physical gold would likely take a hit, hurting the mining companies that produce gold as well.
The latest consensus estimate suggests that the Fed will raise rates by 25 basis points three separate times in 2017. If this prediction comes true, gold could certainly have its struggles as some investors switch out of the yellow metal and into perceived-to-be-safer interest-sensitive assets. But keep in mind that we entered 2016 with the expectation of four interest rate hikes and received just one. These are "estimates" for a reason.
Long story short, the Fed will hold a lot of weight on the movement of gold in 2017.
The Trump factor
Another major catalyst is going to be the Donald Trump presidency. In general, uncertainty is one of the biggest gold catalysts, and there's no shortage of uncertainty with Trump, who has no political or military experience, set to take the highest office in the land.
Trump's agenda is pretty broad. He wants to completely overhaul the individual and corporate income tax system, implement $1 trillion worth of infrastructure spending over the next decade, and repeal and replace Obamacare, the health law of the land. While a traditional Republican president may have had no issues making this happen with both houses of Congress under Republican control, Trump may not be so lucky. He alienated a number of his party members during the campaign, meaning that passing legislation could prove a lot tougher than expected.
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In particular, the widest uncertainties revolve around what might happen with his individual and corporate tax reforms. Since the U.S. is a consumption-driven economy, the expectation is that putting more money back into the pockets of Americans by simplifying the U.S. tax code to just three tax brackets, as well as making the tax environment friendlier to domestic businesses and foreign investment with a 15% peak corporate income tax, will increase GDP growth. Simultaneously, it's also likely to reduce federal revenue and increase the national debt. How these figures will play off one another is anyone's guess at this point. Can Trump get his tax plans passed? If so, is 3% GDP growth per year achievable? These are questions where the answers will probably take two years or more to flesh out.
We will, however, find out whether Trump can make good on his promises to enact reforms in 2017. If Trump has even the slightest struggles getting his legislation passed through Congress, I would view it as a positive for gold.
The final catalyst is a real wildcard in 2017: India.
In 2015, China replaced India as the largest importer of gold in the world, but that hasn't stopped or slowed the desire of India's residents to hoard the precious metal. Instead of purchasing Indian bonds or buying stock, most of India's residents who have savings purchase gold jewelry as a store of wealth. In 2015, India purchased 700 tons of gold for jewelry, yet it mines just two tons of gold annually.
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India's appetite for gold is great news for precious-metal miners and physical gold, but it's creating a growing problem for its government. As reported in The Conversation, since most of its people have their wealth saved in gold jewelry (which isn't nearly as easily monetized as gold bars) as opposed to rupees, the estimated 20,000 tons of gold in aggregate savings doesn't increase the lending power of its banks. Or, in easier-to-understand terms, India always seems to be running a deficit as a result of its hefty gold imports, and it's a drag on the country's economic growth.
Its government has tried to introduce a plan that allows people to trade in gold for interest-bearing bonds to increase the lending power of its banking system, but after two such attempts, it only wound up netting 14 tons of gold in return.India's response might be to ratchet up import taxes on gold, which could have an adverse impact on gold demand. Of course, the lower gold prices go, the more attractive they might appear to India's citizens, which could lead to a counterbalancing effect on the import tax. In fact, India's 2015 imports of gold rose 12% despite an increase in the gold import tax.
India's policies as the second-largest importer of gold could definitely impact the gold market in 2017.
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