The Gold Debate – Where Do Things Stand In The Gold Market?

A Recurring Pattern

When the gold price recently spiked up to approach the resistance area even Aunt Hilda, Freddy the town drunk, and his blind dog know about by now, a recurring pattern played out. The move toward resistance fanned excitement among gold bugs (which was conspicuously lacking previously). This proved immediately self-defeating – prices pulled back right away, as they have done almost every time when the slightest bit of enthusiasm emerged in the sector in recent years.

There is a well-known resistance area in gold priced in USD between roughly $1360 and $1380. It has become the proverbial watched pot.

A number of observers were concerned about the Economist penning a few positive words about gold, as Economist endorsements of market trends are usually the kiss of death for the trend in question. We would point out though that although the pullback began the very next day, it was luckily not a page one story. As to why the Economist would suddenly endorse the safe haven qualities of gold, we have no idea. It is certainly out of character for the magazine, which is not exactly averse to statist interventionism and similar to most other mainstream financial publications is known to be a staunch defender of the economic status quo, including the fiat money system on which it rests.

The Fundamental Backdrop

As long time readers know, over the past year or so we have often pointed out that the macro-economic drivers of the gold price were not exactly bullishly aligned yet, but seemed to be on the cusp of getting there. In Q4 of 2018  sharply rising credit spreads and falling stock prices finally appeared to tilt the fundamental backdrop clearly toward gold-bullish territory.

Since the turn of the year, the picture has become somewhat muddied again, as credit spreads have tightened and stocks have rallied. The yield curve never got around to steepening, so there was no help from that front at any point. On the other hand, the trend in TIPS yields has become supportive again. The US dollar and commodities are not really going anywhere (yet), so their effect on gold is largely neutral. Bank stocks have been weak relative to the broad market since early 2018, but are recently recovering.

Below are several charts illustrating the situation. We would interpret it as overall neutral for gold prices, but retaining a slight bullish bias (as opposed to the slight bearish bias that prevailed for most of last year prior to the fourth quarter).

The top half shows US high yield and BBB (lowest investment grade segment) spreads. After breaking out with authority in Q4, they have tightened again and are now back at the former resistance area. It remains to be seen whether it will now serve as support. At the bottom on the left is a chart showing the gold price vs. the inverted 5-year TIPS yield. Gold has led TIPS yields this time, which have recently aligned with it. TIPS yields are therefore confirming the recent gold rally. On the right hand side we show the 10 minus 2 year Treasury yield spread as a proxy for the steepness of the yield curve. Portions of the yield curve have in fact inverted recently, but not this particular one. A flattening yield curve is generally negative for gold prices, but once the flattening trend stops a reversal to steepening usually comes next – and that will be supportive.

Top half: the Dollar Index (DXY) has been moving sideways for quite some time, but it has become vulnerable now that the monetary policy bias of the Fed has become less hawkish. To the right we show a very long term chart of the BLS cash commodities index, which illustrates that the long term uptrend in commodity prices remains actually intact so far. The CRB Index fails to show this as it includes the roll-over effect, which introduces a sizable downward bias whenever most commodity futures are in contango. In the near term commodities still look weak – they have failed to rally as strongly as the stock market. In the bottom half we show the SPX, which has recovered smartly (obviously, the tentative wave count we presented early this year did not pan out as advertised) and the BKX-SPX ratio, which serves as a proxy for market perceptions about the soundness of the banking system (hat tip to Steve Saville for adding this indicator to the gold macro-fundamentals arsenal).

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Disclosure: None.

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