I am probably early, but it’s that time again. I am taking off my impostor of a precious metals bear suit and climbing back into full bull mode. I never did feel fully comfortable not being stuffed to the gills with the precious little yellow fellow anyway.
What has changed? Why I am suddenly bullish again?
Well for starters, the price of gold, and especially silver, is down a long way from the highs of only a few weeks ago.
Although we have shaken off some of the late longs, we have not seen the full scale liquidation of speculative position that I was hoping for.
But that’s not stopping me from climbing back aboard the bull bandwagon. I have resigned myself to the fact maybe we won’t get a complete abandonment of precious metal positions from the big speculators.
I am comforted that when I scan my inbox of research, I see of bunch of headlines like this:
GARTMAN: ‘Not yet confident’ of GOLD rebound. Reducing holdings.
BofA says BUY world’s worst stock market, SHORT GOLD.
Gold’s drop below 200 day moving average may trigger more losses.
For the first time in a long while there is even a vocal short community on twitter whooping it up on every gold downtick.
The precious metal bulls have been silenced with the recent decline, but if you step back and look at the charts, it doesn’t appear to be anything more than a natural correction in a longer term uptrend. A retracement of 50% or 62% is to be expected in any bull market.
What is worrying the gold bulls? Why can’t precious metals get up off the mat?
Like it or not, the Federal Reserve has signaled an intention to raise rates at the upcoming December meeting. This hawkish bias has caused the US dollar to resume its upward trend.
It is not quite this easy as there are a lot of moving parts, but the US dollar rally is weighing heavy on precious metals.
But causing even more concern is rising long term interest rates. This next chart of gold versus 10 year yields is the sort of analysis causing gold to be offered on every bond downtick.
Between the US dollar rally and the bond market sell off, gold’s decline is not that hard to understand.
I am short way too many bonds, so buying some gold and silver in here might be a natural hedge, but that’s not why I am pulling the trigger on some blue tickets.
No, I am buying precious metals because I expect these correlations to break down.
Let’s start with the idea that gold should move in lockstep with interest rates. I will buy the idea that over the short run the two securities are correlated. But gold is actually more sensitive to real rates than nominal rates. That is why even though nominal rates were quite high in the mid 1970s, inflation was even higher, causing negative real rates. Gold exploded higher and did not stop rising until Volcker raised interest rates above the rate of inflation. So although interest rates definitely influence the gold price, it is their relative position versus inflation that truly determines the price of gold.
Even though I expect interest rates to rise, I expect inflation to rise even faster. I know, I know… it can’t happen. No way either interest rates or inflation is ever going up again. Yet almost all inflation measures have been ticking higher. The core CPI is a perfect example:
I can just hear the complaints now. But commodities are headed lower. China is imploding and will cause deflation. Well, that might be true, but I don’t see it.
Here is a chart of the CRB Raw Industrials index. I use this index because it is less prone to speculative positioning and more accurately reflects a true cost for commodities used in actually producing things.
Sure looks like raw industrial commodities are bid.
Which brings me to my next point about the US dollar causing commodities (including precious metals) to decline. This relationship is not inviolate. All you need to do is look at this same CRB Raw Industrials index versus the inverse US dollar index:
Although the US dollar has been highly correlated to this commodity index, this relationship has already started breaking down. The entire US dollar rally of the past month has done nothing to this commodity index.
There is no reason why gold and the other precious metals need stay correlated to the US dollar.
I expect the US dollar and long term yields to rise in the coming months, but contrary to popular belief, I suspect gold and silver will also join the party.
When the market realizes that interest rates are heading higher because of a rising inflation, there will be a scramble to sell bonds and buy gold. Remember the one outcome that no one is positioned for is a return of inflation…
Thanks for reading,