By Nigel Somerville | Sunday 17 January 2021
It was all looking so rosy. The correction from $2063 which started last August seemed to have played out, a low had been put in at $1776 and recovery was well on the way as the yellow metal rose and rose again to over $1950. And then we hit a bump in the road and we’re back down to around $1830. Even ShareProphets’ favourite technical analyst was taken aback by the drop: I hate to say it, but it looks as though Jordan Roy-Byrne of TheDailyGold.com has finally got something wrong!
At $1950, the Gold price had overcome an apparently significant resistance level from a charting point of view. My rather simpler view was that it had again overtaken its previous high back in 2011. Given the extraordinary level of central bank money-printing, that was not a surprise to me and I fully expect Gold to make new highs in the coming months. But that won’t be just yet.
So what cause this bump in the road? Was it the attack on the Capitol in Washington? Maybe the second impeachment of Donald Trump? I can’t see that – I would have thought Gold would advance under such circumstances. As Jordan Roy-Byrne might explain, that was all just “noise”.
The fundamental drivers for the yellow stuff are inflation expectations and interest rates. 10-year US Treasuries closed last week on a yield of 1.08% – a pretty stiff jump at a time of easy (or just free, given that it comes from the Fed’s magic money tree) money from a yield of a shade over 0.5% last August. Indeed, 10-year the yield peaked last week at almost 1.2%. This suggests that the bond market sees interest rate rises coming this way, and that is bad for gold as it pays no interest.
Normally one would expect shorter bonds to follow suit – I have discussed this before. If interest rate hikes are coming then that should eventually be reflected in 2-year treasury yields rising – the 2-year yield acting as a proxy for what the Fed will do. But they haven’t really budged.
Since August, 10-year yields have more-or-less doubled, putting on just over half of one per cent. 30 year yields bottomed out at around 1.2% last August and put in a high last week of over 1.9%. But 2-year yields, which began last August at 0.1% closed last week at 0.135%. They have hardly moved.
It seems to me that the playbook is that when 10-year (and, for that matter, 30-year) yields rise Gold is seen as a sell because rates will be on the up and that is usually a sign that the economy is improving and thus danger receding.
But 2-year yields aren’t playing that tune. The Fed is posturing about tightening policy, but Uncle Sam cannot afford a rate hike. Just as in the UK, smaller businesses – and some not so small (the airline industry…) are going under at a rate of knots. A rate hike would finish them all off. Jobs are being shed in all directions (with the exception of Amazon) and the US government is, like all Western governments, borrowing like there is no tomorrow.
So why are long yields heading north whilst the short end is marooned? Well, either the bond market can see that the Fed cannot raise interest rates, or the Fed’s QE programme is distorting the market. Or both. But if 2-year yields are not rising (meaning no rate-hikes are expected) yet long yields are on the up (suggesting inflation) then Gold will surely head north, for real interest rates will be falling.
Of course, there is another scenario: long yields fall back again as the full extent of the economic damage is finally revealed. But that would send Gold north as well.
Right across the West, government borrowing and debt are out of control. One way out would be to raise taxes and chop government spending but I just don’t see that happening – it is too difficult, politically. The easy option is to let inflation out of the bottle to erode the value of the debts and to hold back interest rates. That, I believe, is what the bond market is telling us it expects. Those long enough in the tooth like me will remember what happened in the 1970’s, albeit we don’t have an oil price shock and the three-day week to contend with as well. So I don’t see inflation peaking at 25% as it did back then in the UK. But the bond market is telling us that interest rates will be held back and inflation is coming.
So my message is that you should hold on to your Gold, and gold-producing equities – which are a geared play on the Gold price. It is all a matter of patience.
Right now, it seems that the crowd is against us – but those who have read Extraordinary Popular Delusions (originally, the title continued and The Madness Of Crowds) will know that we have seen all of this before. John Law and the Mississippi project – the disaster of currency debauchment. The South Sea Bubble – tech stocks? And whilst it could all be different this time, could we end up looking back upon BitCoin as Dutch Tulips? With an economic backdrop which looks uncertain at best, debt and deficits levels screaming red yet equity markets are near record highs, the writing is surely on the wall for difficult times ahead.
With thousands of years of history to look back over, I suggest that Gold is the way to go for a good while yet.
We will have our day.
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