It Looks Normal But it Ain't
Buy equities and sell gold because the economy is strong and the Fed is supportive? Really? We think you should not be fooled by the reigning narrative.
The Logic Behind Buying Gold Now
In our view, the gold story is getting much simpler and much more urgent.
Fed Policy Turns in Favor of Gold
On January 30th, 2019, the Federal Reserve issued a statement confirming an abrupt about face. After five years of promising 'normalization' of monetary policy and a pre-set path that included eight rate hikes and the sale of hundreds of billions of dollars in assets, the Fed paused in mid stride, thereby opening the door for a new gold bull market. The Fed's path to monetary normalization reverted to flexible data-dependency almost overnight. Suddenly, rates could now go up or down and the balance sheet could shrink or grow.
The FOMC Opens the Door to a Higher Gold Price
Yesterday's FOMC statement and the subsequent news conference with Chairman Powell removed the last significant headwinds for gold. We think that a new bull market for gold is about to commence.
Signs of Stress in Credit Markets
Like passing a major accident on the highway, investors are fixated on the stock market. We urge you to pay at least equal attention to credit markets. QE (Fed purchases of assets) had its most important impact on credit markets...slashing interest rates, expanding credit, lowering credit standards, weakening covenants and encouraging excessive risk-taking in a reach for yield. We expect the most important impact of QT, the Fed sale of assets, will therefore also be seen in credit markets.
Markets Reject the Fed?
On Wednesday, the Fed raised the Fed Funds rate by a quarter point as expected. The FOMC statement was suitably 'dovish' by reducing the consensus forward guidance on future rate hikes from three to two. The Fed also signalled that its Quantitative Tightening program would continue on "autopilot" as planned. The response was not what the Fed expected. Stocks fell hard and bonds soared.
The Gold Market Is Turning (We Think)
As we have noted, markets are deep into what we have called the Tariff Trade based on the assumption that Trump would win his trade war with China and that he would do so before it had any serious negative impact on the US economy. The Tariff Trade was to go long certain US equities and the dollar and short the yuan, commodities and gold. The result? As many commentators have noted, the gold price has been tightly correlated to the Chinese yuan since the trade war was initiated by President Trump six months ago.
Why the Next Market Crash Will Not Take Gold Down
The global financial crisis of 2008 was essentially caused by excessive leverage, a loss of confidence in real estate credit and a resulting sudden collapse of liquidity in the financial system. The central bank response was to lower interest rates and flood markets with liquidity. Since then, debt loads have increased more than 30% and the percentage of higher risk credit has also grown sharply. Many analysts believe that another crisis is possible due to a combination of enormous leverage and deteriorating credit standards. What will happen to gold if we have another financial crisis?
For Gold, It's All About the Dollar
Positioning, sentiment and market structure favour a powerful rally in gold. The COTs released by the CME on September 7, 2018, show the gross speculative short position grew 1.3% to 213,259 contracts, just shy of the all-timer record set two weeks ago. On a net basis, speculators are short 13,500 contracts, the largest short position since December, 2001.
Is Gold Now A Beach Ball Under Water?
The CME COT report of July 27 shows non-commercial gold shorts have suddenly spiked to a 25 year high. Over the past five years, every similar spike in short interest (red arrows on the chart below) has led directly to a short squeeze rally in the gold price, with an average gain of 12.5%. Why should this time be any different?