A Beginning Shift in Gold Fundamentals

A previously outright bearish fundamental backdrop for gold has recently become slightly more favorable. Ironically, the arrival of this somewhat more favorable situation was greeted by a pullback in physical demand and a decline in the gold price, after both had defied bearish fundamentals for many months by remaining stubbornly firm.


The eternal popularity contest…


The list of gold fundamentals that have improved is short, but at least there is now such a list:


  1. credit spreads: European high yield spreads have broken out to the upside. In the US, high yield spreads are better behaved (we suppose mainly on account of the fortunes of the energy sector), but spreads on the the lowest rated investment grade category (BBB) have also seen a textbook breakout to the upside.
  2. emerging market currencies, stocks and bonds have come under pressure on a broad front (this is not just confined to Argentina and Turkey anymore).
  3. stock market volatility has increased globally.
  4. bank stocks have entered a downtrend relative to the broad market
  5. commodity indexes remain in an uptrend (mainly driven by energy prices).
  6. US federal debt is expanding surprisingly fast. This is happening amid a decline in federal tax receipts, which is astonishing in view of reported economic growth rates. Note that the most recent y/y decline in tax receipts happened in Q1, i.e., before the tax cuts came into force.
  7. the proprietary Incrementum Inflation Indicator has recently switched to a “full inflation signal” (on June 28). This indicator is based exclusively on market price signals.


Credit spreads strike us as the most important of these factors as proxies for the trend in economic confidence. Here is what the situation in European junk bond spreads and US corporate BBB spreads looks like at the moment:


European high yield spreads and US BBB spreads: textbook upside breakouts


Examples of historical trend changes in credit spreads and how they played out can be reviewed here: “Credit Spreads: the Coming Resurrection of Polly”. The last three charts in this article show credit spreads turning up after having been stuck at extremely low levels for extended time periods. These charts explain why we are referring to the moves shown above as “textbook” upside breakouts.

The growth rate of the US federal debtberg strikes us as fairly important for the gold price as well. Empirically it often appears to be a major driver, although it could of course be argued that rapid surges in budget deficits and the federal debt are simply symptoms of the type of fundamental backdrop that is traditionally favorable for gold.

What makes the recent trend particularly interesting is actually the fact that the prevailing economic environment is normally not associated with declining tax receipts and sharp increases in federal debt – on the contrary. And yet, federal tax receipts were down 4.5% y/y in Q1, continuing the weakness in evidence since Q4 2015.


Federal debt and federal tax receipts – the former has resumed growing by leaps and bounds, while growth in the latter has turned negative again in Q1 2018 to the tune of -4.5% y/y – and that was before the tax cuts came into force.


Real Interest Rates and the “Inflation” Question

As our readers are no doubt aware, actual inflation – i.e., the growth rate of the money supply – has slowed rather noticeably. This is normally considered gold bearish, but just as gold bottomed and turned up with the beginning of the rate hike cycle (normally also held to be bearish) it started to firm shortly after the downtrend in the true money supply growth rate got underway.

There is no need to rehash in detail why this happened – the short version is:  the gold market appears to be leading future changes in economic conditions and monetary policy by uncommonly long time periods in recent years (this has been the case since 2005). It seems to be more sensitive and forward-looking than any other market in this respect.

It seems that market participants are anticipating the lagged effect of slowing money supply growth on risk assets and the economy and the eventual (inevitable) response of monetary authorities. Along similar lines, when “QE3” was announced in 2012, the gold price started to decline in anticipation of the eventual end of debt monetization by the Fed and the beginning of a new tightening cycle  – and yet, it still took more than three years before the first rate hike was actually implemented.

Regardless of the length of this lead time, gold prices definitely respond strongly to real interest rates, or let us rather say, to market perceptions about real interest rates.


The time shortly before inflation expectations change.


Investors express their views on future changes in CPI through the prices they are prepared to pay for TIPS (inflation-protected treasuries). Since they are market-driven, TIPS yields are the best real interest rate measure at our disposal. Not surprisingly, there is normally a strong negative correlation between the gold price and 5-year TIPS yields.

In the chart below we have inverted the TIPS yield in order to make it easier to see what has recently happened:


After maintaining a near perfect negative correlation for quite a long time (depicted as a positive correlation above via inverting TIPS yields – note that the TIPS scale to the left has to be multiplied by [-1] to make sense), gold prices and real interest rates part ways in early 2017. Recently the gap has narrowed a bit, as both TIPS yields and the gold price have declined. Still, this particular indicator actually remains bearish at this point.


There is another, less future-oriented way of looking at real interest rates, which consists of simply comparing the level of short term rates administered by the Fed to the most recent y/y rate of change in CPI. While this approach has many flaws, it shows how “far behind the curve” Fed policy is in the here and now relative to CPI. Moreover, it allows for comparisons with data of the more distant past, when TIPS didn’t exist yet.


A Tale of Two Eras

The chart below compares two eras – in particular the time period from 2010 until today (which obviously includes the 2011 – 2015 cyclical bear market in gold) and the 1970s gold bull market. Both are juxtaposed with the “real” federal funds rate (defined as the nominal FF rate minus CPI).


Two eras compared: gold price vs. the “real” federal funds rate 2010-2018 and 1970- 1980.


The charts reveal an interesting parallel: both during the 2011-2015 bear market and the 1974 to 1976 mid-cycle bear market, the “real” FF rate first reached deeply negative levels close to the peak, and then rose until it briefly eclipsed or touched the zero line. Both bear market periods incidentally generated almost identical losses (-45.5% in 2011-2018, -46% in 1974-1976).

It is worth noting that the fundamental backdrop for gold became progressively less supportive for gold between 1976 and 1980, especially compared to the first bull market phase.  And yet, the run-up in gold prices only became “parabolic” in 1979-80, with gold stocks ultimately projecting even bigger gains. Their peak lagged the top in the gold price by almost 8 months: the Barron’s Gold Mining Index only topped out in September 1980, while gold concurrently made a lower high (at $720 vs. the $850 peak of January 1980).

The enthusiasm that characterized the secular gold price peak of 1980 was far more pronounced than that seen at the 2011 top, which looks more like a cousin of the 1974 mid-cycle peak to us. The divergence with gold stocks is particularly telling: in 1980 the more speculative part of the gold universe only topped after the more conservative one.

This is precisely the behavior we tend to see around major stock market peaks as well. These are usually marked by the more speculative Nasdaq stocks topping well after the DJIA and/or the broad market. While we would caution that things don’t always have to play out the same way, all of this suggests to us that the probability that the secular bull market in gold still has further to go remains relatively high.


At major bubble peaks, the irrationality of the herd tends to become palpable…


Charts by: St. Louis Fed, cartoons by Hedgeye




Emigrate While You Can... Learn More




Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.


Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA


Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • Venezuela – An Economic Catastrophe in Charts
      The Final Stage of a Crack-Up Boom For economists the dire downward spiral of Venezuela's economy holds the same fascination black holes hold for physicists. Both illustrate what happens amid the most extreme conditions imaginable. It is thought that this may potentially provide clues of a more general nature. The remnants of massive imploded stars are inanimate and many light years distant; regardless of how violent conditions in their vicinity are, they cannot touch us. Unfortunately,...
  • The Degrading Facts of a Fake Money Hole in the Head
      Squishy Fact Finding Mission Today we begin with the facts.  But not just the facts; the facts of the facts.  We want to better understand just what it is that is provoking today’s ludicrous world. To clarify, we are not after the cold hard facts; those with no opinions, like the commutative property of addition. Rather, we are after the warm squishy facts; the type of facts that depend on what the meaning of ‘is’ is.   Fact-related pleas... [PT]   The facts,...
  • Thirteen Reckonings Hanging in the Balance
      A Fake Money World The NASDAQ slipped below 8,000 this week. But you can table your reservations.  The record bull market in U.S. stocks is still on. With a little imagination, and the assistance of crude chart projections, DOW 40,000 could be eclipsed by the end of the decade.  Remember, anything and everything’s possible with enough fake money.   Driven by a handful of big cap tech companies, the Nasdaq Composite has made new highs – but the broad market (here shown in...
  • Jayant Bhandari - The US Dollar vs. Other Currencies and Gold
      Maurice Jackson Speaks with Jayant Bhandari About Emerging Market Currencies, the Trade War, US Foreign Policy and More Maurice Jackson of Proven & Probable has recently conducted a new interview with our friend and occasional contributor to this site, Jayant Bhandari, who is inter alia the host of the annual Capitalism and Morality seminar.   Maurice Jackson (left) and Jayant Bhandari (right)   A wide range of topics is discussed, from the strong US dollar and...
  • Gold-Silver Ratio Message - Precious Metals Supply and Demand
      Fundamental Developments Last week the price of gold fell three bucks, and that of silver fell a quarter of a buck. But let us take a look at the supply and demand fundamentals of both metals. Also, we have an interesting development in the gold-silver ratio, a topic we have not addressed in a while. First, here is the chart of the prices of gold and silver.   Gold and silver priced in USD   Next, this is a graph of the gold price measured in silver, otherwise...
  • September – The Most Dangerous Month to Invest
      The Biggest Crashes in History Happened in September and October In the last installment of Seasonal Insights we wrote about the media sector – an industry that typically tends to perform very poorly in the month of August. Upon receiving positive feedback, we decided to build on this topic. This week we are are discussing several international markets that tend to be weak during September and will look at what drives this recurring pattern.   Mark Twain, a renowned...
  • US Equities – Approaching an Inflection Point
      A Lengthy Non-Confirmation As we have frequently pointed out in recent months, since beginning to rise from the lows of the sharp but brief downturn after the late January blow-off high, the US stock market is bereft of uniformity. Instead, an uncommonly lengthy non-confirmation between the the strongest indexes and the broad market has been established. The chart below illustrates the situation – it compares the performance of the DJIA (still no new high since January, although...
  • Gold-Silver Ratio Hits 10-Year High - Precious Metals Supply and Demand
      Fundamental Developments The price of gold dropped five bucks, and that of silver 40 cents last week. But let’s take a look at the supply and demand fundamentals of both metals. Also, we continue to follow the development in the gold-silver ratio.   One can buy a lot of silver for one's gold these days. Silver has become extraordinarily cheap, but keep in mind that it was even cheaper vs. gold in the early 1990s (see the section on silver further below for the details)....
  • Honest Work for Dishonest Pay
      Misadventures and Mishaps Over the past decade, in the wake of the 2008-09 debt crisis, the impossible has happened.  The sickness of too much debt has been seemingly cured with massive dosages of even more debt.  This, no doubt, is evidence that there are wonders and miracles above and beyond 24-hour home deliveries of Taco Bell via Door Dash.   The global debtberg: at the end of 2017, it had grown to USD 237 trillion. Obviously this is by now a slightly dated figure, as debt...
  • Corporate Credit – A Chasm Between Risk Perceptions and Actual Risk
      Shifts in Credit-Land: Repatriation Hurts Small Corporate Borrowers A recent Bloomberg article informs us that US companies with large cash hoards (such as AAPL and ORCL) were sizable players in corporate debt markets, supplying plenty of funds to borrowers in need of US dollars. Ever since US tax cuts have prompted repatriation flows, a “$300 billion-per-year hole” has been left in the market, as Bloomberg puts it. The chart below depicts the situation as of the end of August (not...
  • Dubious Prophecies & Perverse Incentives - Precious Metals Supply and Demand
      Suspect Predictions, Ill Wishes and Worthwhile Targets of Scorn This price of gold fell three bucks, and the price of silver fell ten cents last week. Perhaps because of the ongoing $150 price drop so far since April, we saw some doozy email subjects and article headlines this week.   Panic on the inflation Titanic. [PT]   One notable one, from the man who confidently asserted we will have hyperinflation by the end of the year — in 2009 — now says that the...

Support Acting Man

Item Guides

Austrian Theory and Investment


The Review Insider


Dog Blow


THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts


Gold in USD:

[Most Recent Quotes from www.kitco.com]



Gold in EUR:

[Most Recent Quotes from www.kitco.com]



Silver in USD:

[Most Recent Quotes from www.kitco.com]



Platinum in USD:

[Most Recent Quotes from www.kitco.com]



USD - Index:

[Most Recent USD from www.kitco.com]


Mish Talk

Buy Silver Now!
Buy Gold Now!