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Why the Risk-to-Reward Ratio Could Favor Gold Bulls Now

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Aug. 9 2018, Published 12:43 p.m. ET

Gold’s diminishing luster

Gold prices (IAU) have been on an almost one-way downward trajectory since mid-April. This trend resulted from the US dollar’s strength as well as diverging monetary policies in the United States (IVV) and the rest of the world. This period has marked gold hitting fresh one-year lows multiple times.

Although the Federal Reserve didn’t raise rates during its August meeting as was widely expected, it sounded more bullish on the US economy (SPY)(DIA). It noted that “economic activity has been rising at a strong rate” from June’s characterization of “solid” growth. 

The Fed was also upbeat on household spending and business fixed investment in the US. Now, market participants are almost unanimously expecting a rate hike in September.

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Competing against income-yielding assets

Investors should note that gold has a hard time competing with income-yielding assets. These assets are attractive when interest rates (TLT) are high because gold doesn’t generate any income. The US dollar’s (UUP) attractiveness to the rest of the world is expected to increase, especially when their central banks are following a loose monetary policy. As a result, the strong dollar has a negative impact on gold.

Factors driving gold prices

Gold (GLD) has lost nearly 10.0% from its April peak. The downward momentum is occurring despite rising trade war concerns, which are usually conducive to gold’s safe-haven appeal. The US dollar has become a safe-haven investment, which has pressured gold.

Due to gold’s recent slide below $1,220 per ounce, investors are wondering whether gold could hit the psychologically important level of $1,200 per ounce. In this series, we’ll look at gold’s recent behavior and discuss its outlook based on its drivers.

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