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Gold Rally Fades: Buy ETFs on the Dip or Short?

After witnessing its third consecutive annual decline in 2015, gold delivered an all-star performance in early 2016. A spike in volatility emanating from the Chinese market rout, overall global growth worries and nagging oil price declines to start 2016 brightened the safe haven demand for the yellow metal. Also, a soggy dollar in the wake of moderation in U.S. growth led this metal to see the best Q1 rally in 30 years (read: How to Trade in Gold ETFs After Robust 30-Year Rally?).

Fed Hike Bets Dull Gold

When market watchers were almost sure about a delayed policy tightening in the wake of the threats to the stability of the U.S. economy, the latest Fed minutes hinted at the possibility of a June hike. This is because the U.S. economy came up with some stellar economic readings for the month of April and the global market upheaval eased a bit. Oil prices also hit a six-month high, signaling stabilization in global market investing.

Needless to say, speculation of a sooner-than-expected Fed hike boosted the so-far-struggling greenback and the optimism around gold investing, which bears no interest, started to drain. In fact, gold logged ‘the longest slump in more than two months’ recently on a stronger U.S. dollar.  Gold now hovers around $1,246/ oz (as of May 23, 2016).

The Fed enacted a rate hike in December and two more rate hikes are due this year if everything goes well. Chances of a June rate hike jumped to 30% from 4% a week ago, as per Fed fund futures data.

Rising rate concerns always go against gold as evident from the previous returns of the largest gold bullion ETF SPDR Gold Shares (GLD).  The fund lost over 11% in 2015 (the year the Fed hiked rates) after a 3.8% decline in 2014 (the year the Fed wound down its QE) and 28.8% in 2013 (the year market was abuzz with taper talks) (see all precious metal ETFs here).

Any Way Out from This Slump?

Safe Haven Demand: The possibility of a lackluster stock market due to Fed-induced worries, political risks due to the presidential election in the U.S., occasional crashes in global stocks (like what we saw in 2015 after China’s currency devaluation), geo-political issues like Brexit worries and terror attacks should bolster the safe-haven appeal of gold, irrespective of Fed hikes.

If the Fed Goes Slow: Even if the Fed hikes rates in the coming one or two months, the pace of hike may slow down after that. It is very unlikely that the Fed will enact two close hikes as assessment of the U.S. economy after a single hike would be crucial and maybe time-taking. This slow rate hike trajectory may keep the greenback from shooting higher (read: How Well will Gold Mining ETFs Weather a Rate Hike?).

Higher Inflation = Fed Hikes = Higher Demand for Gold

Gold is often viewed as a hedge against inflation. Now with oil prices shoring up and several economies on the mend, global inflation should pick up.  This is especially true for the U.S. economy. One of the pre-requisites of the Fed hike is higher inflation. So, if the Fed makes a move, there must be some noticeable uptick in inflation, which in turn is likely to boost demand for inflation-protected assets like gold.

Demand Exceeds Supply: Gold demand grew 21% year over year in the first quarter of 2016, representing the second largest quarter on record, as per world gold council. Supplies were miniscule compared with demand as the former rose just 5%. Demand was bolstered by the massive inflows into exchange traded funds.

What Do Analysts View?

Denmark’s Saxo Bank A/S believes that bullion may hit as much as $1,400 an ounce this year.

J.P. Morgan is in favor of a possible $1,400 by the end of this year. Negative interest rates in several developed economies are behind this optimistic forecast, as nearly $8 trillion in global sovereign debt is caught in the web of negative yield.

BNP Paribas is yet another believer of $1,400 gold over the coming one year (read: Gold ETFs to Continue Their Bull Run: Here's Why?).

Goldman has a 12-month target of $1,150 an ounce, up from the previous target of $1,000 an ounce. However, this implies a 7.7% decline from the current level.

Natixis, a French bank, also upped its gold forecast for 2016 by 22% to about $1,185 an ounce from its prior forecast made in October. But it means around 4.9% downside from the current level. However, the bank sees a troublesome 2017 for gold bugs, projecting prices at $1,060 an ounce, up somewhat from its prior guidance of $1,020.

Macquarie raised its gold forecast by 5% for 2016 to $1,199 per ounce (down about 3.8% from the current level) and by 3% for 2017 to $1,251. The bank expects prices to go up to above $1,400 in 2019.

How to Profit via ETFs?

From the above discussion, we can say that gold prices will fall in the short term due to a surge in profit booking amid renewed Fed hike concerns. If this happens, investors can play the slump in gold via inverse ETFs like DB Gold Double Short ETN (DZZ) and Power Shares DB Gold Short ETN (DGZ) (read: Short Gold with These ETFs).

Investors can also play AdvisorShares Gartman Gold/Euro ETF (GEUR) as euro is likely to sink ahead against the stronger U.S. dollar. CurrencyShares Euro ETF (FXE) lost about 1.1% in the last five trading days (as of May 23, 2016).

However, investors can play gold bullion ETFs like GLD and IAU, if things turn in favor of gold in the medium term. But chances of this are slim at the current level. Only inflationary pressure, a sudden global market crisis and a slow Fed could take gold higher.

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SPDR-GOLD TRUST (GLD): ETF Research Reports
ISHARS-GOLD TR (IAU): ETF Research Reports
DB-GOLD DBL SHT (DZZ): ETF Research Reports
DB-GOLD SHORT (DGZ): ETF Research Reports
ADVSR-GT G/EUR (GEUR): ETF Research Reports
CRYSHS-EURO TR (FXE): ETF Research Reports
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