Has gold lost its shine?

When Britain voted to leave the European Union, share markets around the world plummeted, including Australia’s own S&P/ASX 200 index. But one sector that stood out was gold, which rallied strongly.

Monday marked one of the worst days for the local share market since the Brexit falls of Friday, 24 June. The decline, which followed a dip on Wall Street, came after signs that central banks around the world are reaching the tipping point when it comes to monetary stimulus.

In the United States, Eric Rosengren, a Federal Reserve policymaker, suggested interest rates in that country need to rise sooner rather than later, or else risk their economy becoming overheated. Those comments have been somewhat mitigated by Federal Open Market Committee governor Lael Brainard – who insists interest rates must remain close to zero for longer – in the time since, but there is still a chance of a rate hike in September. The probability of a rate hike in December is considered a coin toss.

Indeed, questions have been raised about the sustainability of ultra-low interest rates, and how long we can continue to rely on them. European Central Bank president Mario Draghi has also indicated his hesitations to continue relying on monetary stimulus, instead preferring for government policy to help propel future economic growth.

Of course, equity markets around the world have also been pushed higher by the developed world’s low interest rate environment. So you can understand why some investors would be nervous by talk that interest rates could soon march higher.

Not all that glisters is gold

Unlike the day that followed Britain’s controversial vote to leave the EU, gold failed to flourish in the wake of Monday’s falls. In fact, the opposite happened.

The gold miners were among the worst performers during Monday’s rout, continuing a trend that has become increasingly noticeable in recent times.

Silver Lake Resources fell almost 4% during the day and is down more than 17% over the past month. Newcrest Mining and Northern Star Resources have both lost 14% over the last month while Evolution Mining is down 8%.

The ASX 200 has also fallen over that time, mind you. It’s down just over 5%; not pretty either, but not as bad as the miners. So, the question is, why are gold shares suddenly on the chopping block?

Gold prices tend to rise in the face of heightened uncertainty, which is why so many miners soared in response to Britain’s vote to leave the EU. The ‘Leave’ decision was unprecedented, and nobody knew quite what to make of how it would impact the global economy. Thus, gold prices rose.

The problem, however, is that gold is merely a metal. A precious metal, yes, but one that still sits idle. It doesn’t grow, nor does it pay interest or a dividend.

To quote a famous investor who goes by the name Warren Buffett:

“Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

With interest rates around the world sitting at very low levels, there hasn’t been as much of an opportunity cost for gold investors. In other words, many have been happy to hold onto gold – which yields nothing – because the potential yields from government bonds and term deposits are also extremely low.

But increasing interest rates in the United States have the potential to change that. Yes, lifting interest rates will be a gradual process, but is still likely to take some of the shine off gold. It’s already fallen to US$1,330 an ounce, down from US$1,350 an ounce just last week.

Foolish takeaway

Gold has been one of the brightest sectors on the ASX so far in 2016, and for good reason. A rising spot gold price and high levels of uncertainty have certainly had a positive effect. But gold isn’t guaranteed to rise from here, and a hike in U.S. interest rates could certainly dampen its prospects. As such, it might pay to give the gold miners a miss for now.

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Motley Fool contributor Ryan Newman has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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