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Commodities Analysis
Gold has historically been used as a store of wealth, especially in the past when gold was the basis of money. Even though gold mining has continued and become more prolific, and you can’t destroy it, there’s still that sense of scarcity after many millennia. Due to its properties, we have also assigned it a higher value than the more abundant silver, emphasizing its scarcity and this is a reminder of why people say it serves as a store of value.
Considering it’s just a piece of metal that usually just sits around adding no real value to anyone or anything, it has done well to serve as different things to different people. It looks attractive to humans, and 5000 years of programming have made us all feel its allure. Technology advancements and the conductive properties of gold has given the element some practicality.
However, when the value of gold is expressed in US dollars, the monetary store becomes even more apparent as we can measure the purchasing power of gold versus a selection of currencies. When the US government and institutional banks need new fiat money, they can create it from nothing. This inflation of fiat money makes each US dollar worth less. As the value of a dollar depreciates, something scarce like gold appreciates. The destruction of fiat money has clearly begun after over 20 years of adding fiat liquidity to the markets, and with monetary policy tightening, and taxes increasing, cash is being removed out of the system.
This is now causing the markets some concern as we are seeing certain assets drop heavily. If things worsen beyond the scope of what central bankers are trying to achieve, the central bankers will go back to the economic supporting measures of adding trillions of dollars as a backstop to the economy, as well as every other currency, to stimulate the economy again. At which time we’ll be back to a low-interest rate, slow economy again.
Milton Friedman explains that inflation is “always and everywhere a monetary phenomenon”. By adding US dollars into the system as per the grants and stimulus packages during COVID, it meant that between 2020-2022, there was more cash, chasing fewer things. The first part is monetary inflation. Adding more US dollars to the pot. Having more money available pushed the prices of goods that were in demand and in low supply, higher. This phenomenon affected all aspects of life, including items like second-hand cars, and even down to things like pressure cookers.
Last Friday the US CPI data reached an unexpected high, and now the calls are for the Fed to react to that data point and add another 75bps to the headline rate. The CPI measures a basket of goods and the rate of change in price for each good, then puts them into the aggregate. The CPI is rising because there are still a lot of people employed in the US, earning more, with an appetite to buy things. But supply chain disruptions are still making some goods scarce. That supply disruption has been amplified by the lack of Russian goods being imported by the West. Adding 75bps to the cost of credit just makes everything more expensive. Until they have added enough additional costs to everything that most people can no longer afford these things, and they are forced to stop buying. When the cost of credit gets too high, and no one can afford to pay back the loan or credit card, then we’ll have an insolvency event.
Gold has nothing directly to do with any of the demand and supply of goods. If anything, it is being directly affected by the appreciation in the US dollar. The lack of US dollars flowing around the system is pushing the price of the US dollar higher, supported by the rising US yields. Gold is more affected by the move into US Treasuries with interest protection (TIPS). This security is designed to react in line with the markets as the inflation goes higher, the assets linked to inflation also appreciate. Thus, making them the safest asset in terms of store of value, to have during higher inflation.
The surprising thing to me is that gold hasn’t already collapsed under the weight of the US dollar and these rising 10-year TIPS. The chart above shows the clear inverse relationship that these two assets have.
Retail sentiment as seen by the ActivTrader sentiment indicator shows that most traders on the platform buy into the notion that gold is a good inflation hedge. What they may fail to realise is that this CPI print is being caused by supply chain disruptions, the energy sanctions, and relatively less money in the system.
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On the monthly chart the price of gold has done its best to counter the additional money that was directly pumped into the system. But now that has been taxed away and people’s savings have been raided, the managed money is going into TIPS etc. Just below $1400 looks like a good breakout level to test for support, along with the monthly 200-period EMA. Other analysts are looking at the above chart and seeing a possible bull flag or cup and handle chart pattern. Both of which are bullish continuation patterns.
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On the daily chart the MACD has flipped to being bearish because of yesterday’s massive selloff and bearish close. $1800 has been a magnet for gold and a lot of buying and selling has occurred there over the past 18 months. Having seen gold test the $2000 level, I am now always on the lookout for reasons to sell rallies as I believe the price of gold is going to test the other side of the range which would be between the $1700 and $1650 zone. A test of Fridays low which has acted as resistance is a good indication that others are also looking to sell the rallies. A close above the $1872 level and any bearish scenario would have to be reconsidered as we could be on for higher highs and higher lows.
