Why Gold Fell in September
Prospect of Additional Rate Hike and Balance Sheet Unwind Curb Gold in September
The momentum gold experienced in August carried over into early September. Geopolitical tension continued as South Korea reacted to possible preparation by North Korea for an intercontinental ballistic missile launch. The U.S. Dollar Index (DXY) fell to new lows (levels not seen since early 2015) when the European Central Bank (ECB) increased its growth forecast and indicated it would begin discussing a tapering strategy for its quantitative easing policies in October. This drove the gold price to its high for the year at $1,357 per ounce on September 8. However, for the remainder of the month, the Federal Reserve (Fed) once again became the primary driver of gold prices, as interest rates and the dollar began to trend higher. After its September 19 Federal Open Market Committee (FOMC) meeting, the Fed announced plans to gradually allow its $4.5 trillion bond portfolio to runoff. It also forecast one more interest rate hike for 2017. Then, following a September 26 speech, the market became further convinced of a December rate increase when Fed Chair Janet Yellen endorsed continued monetary tightening in spite of a subdued inflation outlook. As a result gold trended lower, ending the month at $1,280.15 per ounce for a $41.25 (3.1%) loss.
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As the graph above suggests, a weaker dollar (UUP) has a positive effect on gold (GLD)(OUNZ). Gold prices have climbed 10.6% year-to-date despite the blip in September. Meanwhile, the dollar index has fallen nearly 9% year-to-date (or YTD).
Interest rates are still relatively low, so the Fed still has a lot of leeway to hike rates if need be. This outlook could be a negative for gold in the short term. That being said, markets have already factored in some of the rate hike.
Meanwhile, equity markets continue to outperform. The S&P 500 index (SPY) has risen 14.5% YTD. However, valuations on some of the blue-chip stocks appear rich. Any pullback could cause a small correction on the index. Any major correction could cause investors to flee to safe havens like gold and Treasuries (TLT).