Gold And The Boom-Bust Cycle

The true fundamentals* have been trending in a gold-bearish direction since early-October of last year, which is a large part of the reason that the gold price has been in a downward trend for the past several months. The majority of these true fundamentals are measures of confidence in the economy and/or the banking system, the theory — which is supported by decades of empirical evidence — being that gold performs relatively well in the bust phase of the boom-bust cycle and relatively poorly in the cycle’s boom phase.

Just to be clear, if the US$ is weak enough then it certainly is possible to make gains in US$ terms via being long gold during a boom, but you will do better by being long other things including industrial commodities. Hence the use, above, of the word “relatively”.

Credit spreads are one useful measure of economic confidence, with widening spreads indicating falling confidence and narrowing spreads indicating rising confidence. This implies that the direction and level of credit spreads indicate whether the economy is in the boom phase or the bust phase. That’s why the gold/commodity ratio generally has trended up and down with credit spreads, which is exactly what it should do.

Below is a chart that illustrates the relationship mentioned above. In this case, metals are being compared with metals by looking at how gold performed relative to industrial metals (represented by the Industrial Metals Index – GYX) during periods of widening and narrowing credit spreads.

Unfortunately, the data for the credit spread indicator used in this chart starts in 2007, so for the first eight years of the chart, there is only the gold/GYX ratio. However, a longer-term credit-spread indicator would confirm that gold/GYX’s 2001-2002 upward trend coincided with an economic bust and gold/GYX’s 2003-2006 downward trend coincided with an economic boom.

The chart suggests that there was a major economic boom during 2003-2006 and major economic busts spanning mid-2007 to mid-2009 and Q4-2018 to March-2020. The period from mid-2009 through to Q3-2018 contained a series of relatively minor booms and busts.

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This blog post is a modified excerpt from a commentary published at TSI on 21st February.

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