Most precious metals websites are filled with stories and news from the gold market, accompanied by the implication that they will drive the gold price up. Examples of this include gold coin sales, Shanghai gold withdrawals, central bank buying volumes, evidence of market manipulation, money printing volumes, velocity of money, etc.
The ongoing narrative is that there is a positive correlation between monetary stimulus and the price of gold. However, as you probably know by now, precious metals collapsed during the Fed’s QE to infinity program. The long-term gold chart (first chart below) shows that gold stabilized when the Fed started tapering and around the end of QE, which is very counterintuitive to say the least. That is not to say there is no correlation, but there is definitely not a direct correlation.
This begs the question: what drives gold and the whole precious metals complex?
What humans tend to do is associate ‘events’ with market developments, because we need an ‘explanation’ for everything. Similarly, when trends change, we want to be able to explain why that is happening, and associate it with some sort of ‘event’. This has a drawback, however, as it prevents investors from looking at reality.
To make that point, we have added several “events” to the long term gold chart. Note how gold was rising during QE1 and QE2. When the Fed went ‘all-in’ with its QE to infinity program, gold started to collapse. Clearly, there is no one-to-one correlation between the gold price and ‘the creation of money’, which was widely assumed up to that point.
The truth is that gold’s uptrend in 2011 had lost so much momentum that alternatives started to look much more interesting. As a consequence, gold’s strong trend started turning and it eventually reversed; just because other alternatives had higher yield expectations.
Gold’s fundamental driver: inflation expectation
The clearest driver for gold, in our view, has been inflation expectation. The chart below makes that point. The red line, which represents TIPS (inflation-protected US Treasury bonds), an instrument that reflects real yields for maturities ranging from 5 to 30 years, moves almost perfectly in sync with gold. Similarly, we know meanwhile that disinflation (a slowing level of inflation, not deflation though) is gold’s biggest enemy. That is confirmed by the stabilization of TIPS since mid-2013, which has been preventing gold from rising as the chart shows.
Another thing that stands out on the chart below is that gold does not correlate with interest rates (the grey line). There is a strong narrative currently around interest rate hikes and lower gold prices. The problem with that is the underlying assumption that all other conditions apart from interest rates remain the same, in particular the rate of (dis)inflation. For instance, if interest rates go up in an inflationary environment, we should see gold go up. Remember, it is the interest rate in the context of inflation expectations that drives gold.
One could argue that we are not taking manipulation into account. Manipulation works in both directions, however. When gold was going through one of the strongest and longest bull markets in history, there was also market manipulation. Just like it pushed gold prices higher back then, it has been reinforcing the downtrend since its peak. Consequently, as precious metals have been manipulated lower, there will be a point where the opportunity becomes so attractive that investors will increase their exposure to gold related investments again and we could be very close to that point.
An opportunity in gold brewing?
As time passes and conditions change the opportunity cost to not hold gold-related assets is subject to change as well, and to such an extent that it is turning into an exciting opportunity. We do not know the timing of the turning point but we do know that trends do not continue endlessly.
When gold’s trend changes, everyone will be ready with a ‘reason’ or an ‘explanation’ for the new uptrend. A new narrative will be created. Most investors, however, will enter very late in the new cycle because they are still blinded by the former narrative, the one which says that gold will not go up because of reasons x, y, and z.
If inflation picked up in an environment where the opportunity cost of not holding gold rises, gold would most likely continue its secular bull trend in a big way.
So could we conclude that gold has an attractive outlook and that opportunity cost is rising? Being secular investors, we think so, but we would like to see more evidence.
What we would like to see, ideally, is an indication of rising inflation, which could come in the form of an uptake in economic activity; that would stop the ongoing disinflationary trend. However, there is another form of inflation. If interest rates rise, bond prices would fall. As the bond market is huge compared to other markets, it means that a significant part of those dollars and/or euros will flow to other assets. Because of that, the price sof stocks and commodities, including gold, should inflate.
And there you have our contrarian call. We at SecularInvestor.com are sensing that higher interest rates could become the next trigger to push precious metals higher in the years ahead.
Obviously this is a statement that goes against the ongoing narrative and consequently it is not in the minds of most investors. Why? Because almost everyone believes that gold can only go lower, that interest rates can only go lower, and that there is a one-to-one correlation between interest rates and gold. This has been fueled day after day by mainstream media, as usual.
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