What Really Drives the Gold Price

Today I want to talk about gold. It’s been a while since I have.

I’ve been a gold bull since around 2000. Throughout that time, it’s been in one long secular bull market. It experienced a cyclical bear market from 2012­–15, which absolutely hammered gold stocks.

In the US, while gold stocks have recovered strongly from these lows, they are still well below the all-time highs achieved in 2011.

No wonder gold keeps rising…

I’m not sure whether this is bullish or bearish. I mean, as gold moved to new all-time highs this year (beating the previous 2011 peak), gold stocks couldn’t do the same. Is that saying there’s plenty more to come for gold stocks, or is it saying gold stocks aren’t buying the move to new all-time highs in the gold price?

You know…once bitten, twice shy…

As I said, I don’t know.

Over all the years I’ve been following and investing in gold, the one constant is confusion about what drives the gold price.

The common explanation is that gold rises on the back of inflation concerns. But that is a relic from the 1970s bull market. It’s also a relic of when inflation had just one meaning — inflation in goods and services prices.

Based on my experience, the driving force for gold is monetary disorder. Whether that expresses itself in terms of goods and services price inflation or deflation it doesn’t really matter. It’s the monetary disorder that gold responds to.

And we are definitely in an era of monetary disorder, which is why I remain bullish on gold as a long-term investment.

Since 2008, when the monetary system irretrievably broke, central banks around the world have been pushing the QE button. Australia’s RBA just joined the stupidity. This does nothing for the real economy, as QE is just an asset swap (government debt for bank reserves) and these reserves stay in the system. Banks don’t (actually can’t) lend them out.

QE also drains the system of good quality collateral. This means governments can issue fresh debt (fiscal stimulus) without being penalised. In the post-2008 world, there is a strong appetite for good collateral. This is why effectively bankrupt governments are able to lend, in some cases, at negative interest rates.

So we’ve got a situation where QE doesn’t work as initially intended, but it’s one step away from direct financing of government spending and so central banks continue to use it with gusto.

The result?

Monetary disorder on a global scale. No wonder gold keeps rising.

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To show you what I mean, check out the relationship between US long-term government bond yields and the gold price. The correlation is very strong. In the chart below, the Treasury Bond ETF [NASDAQ:TLT] is in black, with the gold price in green:

Port Phillip Publishing

Source: Optuma

[Click to open in a new window]

When bond yields decline, TLT rises and the gold price rises along with it.

It’s a reflection of a few different but related things.

Firstly, it’s a reflection of ‘money’ becoming cheaper. When yields fall, the capital value of the asset rises. Gold doesn’t have a yield, but it is a monetary asset. Its nearest competitor, government bonds, do have a yield. So when they decline and their capital value rises, gold moves with it.

But why are bond yields declining?

Well, that comes back to QE and massive government fiscal stimulus.

Put simply, it doesn’t work.

As I said, QE is just an asset swap. The money stays in the financial system. As far as fiscal policy goes, in highly indebted economies, it is less effective. It proves a short-term economic boost, but then leaves the economy even more structurally unsound.

Gold is a long-term hedge

The bond market sees through this. It never prices in a ‘recovery’. That’s why, despite all the QE and fiscal stimulus this year, US 10-year bond yields are still well below 1%. That is, no return to strong economic growth and the inflation that comes with strong growth.

Once again, monetary disorder.

That’s not going to change. In the years to come, there will be even greater government involvement in financial markets. They will just keep doing the same thing. They have no skin in the game and will not learn from their mistakes.

So gold, in my view at least, remains a great long-term hedge against this insanity.

But shorter term, I’m not so sure where gold goes from here.

Take a look at the chart above again. TLT has declined (yields rising) over the past few months as the market thinks all the stimulus will spark an economic recovery and inflation. If the gold price were to match that fall, it could go to around US$1,700 in the short term (see left-hand scale).

Alternatively, bond yields could fall again, meaning TLT moves higher and catches up to gold. The thing is, we don’t know which market is the ‘leader’ here. Is it gold or bonds?

Good question…

In the absence of an answer, let’s have a closer look at the gold price.

It’s in the process of consolidating/correcting the big move up that started in mid-2019. So far, the correction has found support around US$1,850. A break below here would see the price move pretty quickly to US$1,800. That’s where the 200-day moving average currently sits.

Port Phillip Publishing

Source: Optuma

[Click to open in a new window]

Looking through a bunch of Aussie gold stock charts, they all look pretty weak. It suggests to me this correction may continue for a bit longer.

But as I’ve told subscribers of my Crisis & Opportunity service, if you have a longer-term view, you should use this period of weakness to ‘accumulate’ gold stocks.

That is, don’t buy aggressively, but chip away over a period of weeks or months to build a position.

In a few years, you’re likely to be very thankful for it.


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Greg Canavan,
Editor, The Rum Rebellion

Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own.

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