The
US dollar has fallen rather sharply over the past year or so,
despite ongoing Fed rate hikes. This persistent dollar weakness has
really boosted gold. There’s a fascinating interplay between these
two currencies and futures speculators’ expectations for Fed rate
hikes. These traders hang on every word from top Fed officials,
which greatly influences their trading. So these relationships are
important to understand.
In
late December 2016, the venerable US Dollar Index surged to an
incredible 14.0-year secular high. That was just a couple
weeks after the Federal Reserve’s second interest-rate increase
of this hiking
cycle. Top Fed officials were forecasting three more rate hikes
in 2017, fueling euphoric sentiment in this top reserve currency.
Everyone believed higher prevailing interest rates would prove very
bullish for the dollar.
Their logic was simple. The more the Fed raised its benchmark
federal-funds rate, the more general rates would rise. That would
boost the yields of dollar-denominated bonds led by US Treasuries.
The higher yields went, the more attractive the dollar would look
compared to other major currencies. Thus global investors would
flock back to the US dollar as the Fed hiked, further extending the
mighty dollar bull.
That
very week I wrote an essay taking an unpopular contrary stance on
the euphoric US
dollar. In it I warned, “Traders
are overwhelmingly betting the dollar’s strong upside will
continue. But this greed-drenched currency looks very toppy and
ready to fall, which is very bullish for gold.” That generated a
lot of flak, but it’s usually the right decision to be bearish when
everyone else is bullish near major secular highs.
Shocking traders,
late 2016’s epically-overcrowded long-dollar trade indeed collapsed
in 2017. That was despite the Fed actually carrying through on
hiking three more times as expected. From that euphoric dollar peak
in late December 2016 to the recent low,
the USDX plunged 14.2% over 13.2 months! By
world-reserve-currency standards that’s massive. This
helped gold surge 18.1% higher over
that same span.
Clearly the usual
higher-rates-are-great-for-the-dollar arguments everyone believed in
late 2016 weren’t correct. Nevertheless, futures speculators
continue to trade based on that faulty premise almost every week.
They rush to buy US-dollar futures and sell gold futures whenever
something seems hawkish and implies more or faster Fed rate hikes.
Once you start watching for this phenomenon, the examples seem
endless.
The triggering
catalysts are often comments from top Fed officials, official
statements released after their policy-setting FOMC meetings, those
meetings’ projections for future federal-funds-rate levels, and any
major US economic data that surprises to the upside. Anything from
these sources considered hawkish is used as an excuse to
aggressively buy the dollar, which in turn convinces gold-futures
speculators to sell.
These elite
futures speculators still fervently believe higher yields driven by
Fed rate hikes will boost the dollar. For many years now most
sizable daily dollar rallies and gold selloffs have emerged from
more-hawkish perceptions on Fed rate hikes. But while the basic
logic sounds reasonable, this ever-popular thesis is torpedoed by
market history. Futures speculators would do way better if they
understood this.
This first chart
takes a multi-decade view of that US Dollar Index and the Fed’s
benchmark federal-funds rate. The FFR is actually a free-market
interest rate the Fed can’t directly control. Banks are required to
maintain reserves at the Fed, which they can borrow or lend
overnight if they have temporary deficits or surpluses. This is the
federal-funds market. The FOMC actually sets a target for
the federal-funds rate.
For a decade now
this target has been a quarter-point FFR range. The FOMC’s latest
target from its late-January meeting is 1.25% to 1.50%. The Fed
uses open-market operations to attempt to bully the actual FFR into
its target range. This chart shows the midpoint of the Fed’s target
range. It’s not only far less volatile than the real FFR, but the
Fed rate hikes so enthralling futures speculators are
target-range changes.
Because of the extreme leverage inherent in futures trading,
speculators necessarily have an ultra-short-term time horizon. They
can’t afford to be wrong for long at 25x or greater leverage.
So these guys are often making trades they intend to hold for mere
hours or days, maybe a couple weeks on the outside. They are so
deep in the ultra-short-term weeds that they can’t see the forest
for the trees on Fed rate hikes.
The
Fed’s current rate-hike cycle, which is
actually the 12th
since the early 1970s, was born in December 2015. That initial hike
was highly anticipated, as the Fed hadn’t boosted its FFR target for
fully 9.5 years! The Fed began to prepare the markets for a
new tightening cycle back in mid-2014. The FOMC started to talk
hawkish after long years of its zero-interest-rate policy
implemented during 2008’s extreme stock panic.
On
mere rate-hike hopes, the USDX skyrocketed 25.6% higher over
8.4 months between late June 2014 and mid-March 2015! That was
truly epic, the USDX’s second biggest and fastest rally ever
witnessed. It was only exceeded by a blistering 22.6% USDX rally in
just 4.2 months during that 2008 stock panic on colossal safe-haven
buying. Dollar speculators were unbelievably bullish on the coming
Fed rate hikes.
Since this 12th Fed-rate-hike cycle began in late 2015, the Fed has
indeed hiked 5 times totaling 125 basis points. That’s not trivial
coming off ZIRP, representing a gargantuan 11x increase in
the midpoint of the FFR target range! In absolute-percentage terms
that’s history’s most-extreme hiking cycle since it started from
such a low base. So the resulting higher yields should’ve driven
the USDX much higher, right?
But
that’s not what happened. Even at late-December 2016’s extreme
14.0-year secular high, the USDX was only 5.2% above its levels from
the day before this cycle’s maiden rate hike just over a year
earlier. And over this entire 12th rate-hike cycle’s 26.5-month
span, the USDX has actually slumped 7.7% lower! Obviously
Fed rate hikes aren’t as bullish for the US dollar as futures
speculators continue to widely believe.
That’s no anomaly either. The previous Fed-rate-hike cycle, the
11th of the modern era, ran from June 2004 to June 2006. And unlike
our current one, the USDX entered that last one near major secular
lows. It also saw far-more-relentless Fed hiking, many more hikes
faster. The FOMC raised its FFR target every meeting for 17 in a
row! These 17 rate hikes totaled 425 basis points, dwarfing the
current cycle’s 125 to date.
If
there was ever a recipe for a strong USDX bull, that was it. But
instead of soaring on higher yields as traders assume happens, the
best the dollar could muster was a sideways grind. Over that
hiking cycle’s entire span the USDX actually drifted 3.8% lower!
The Fed’s higher interest rates indeed drove higher yields, but they
didn’t convince global investors to flock back to the dollar. So it
gradually slumped in that cycle.
Maybe it’s high-rate stability the dollar needs. But in the 14.7
months after that last Fed-rate-hike cycle as the Fed’s FFR target
stayed way up at 5.25% continuously, the USDX actually slid a sharp
8.0%! There needs to be hard historical evidence that Fed rate
hikes are bullish for the US dollar. This belief driving so much
big intraday trading shouldn’t be held on mere blind faith. The
USDX hasn’t thrived in higher rates!
The
other side of this coin is lower rates must hurt the dollar.
There’s some support for that at least, as the USDX plunged to an
all-time low in mid-April 2008 following the FOMC slashing
rates. In just 6.0 months the FOMC sliced the FFR more than in half
from 5.25% to 2.25%! Yet despite the FFR target plunging further to
a 0.0%-to-0.25% ZIRP range in December 2008 during the stock panic,
the USDX soared.
The
big down days in that first stock panic in 101 years became more
frequent and larger from July to November 2008. So traders
increasingly dumped stocks to hold cash. That safe-haven demand
again blasted the USDX an astounding 22.6% higher in just 4.2
months! Yet over that span the FFR target was cut in half from 2.0%
to 1.0%. So falling yields courtesy of the Fed certainly didn’t
negate dollar panic buying.
And
if lower yields are so bearish for the US dollar as the
Fed-hawkishness-is-bullish arguments imply, the USDX should’ve
plummeted during the ZIRP years. Yet the dollar instead largely
ground sideways near lows. From the day before the Fed went ZIRP in
December 2008 to late June 2014 just before that sharp
rate-hike-anticipation rally erupted, the USDX merely edged 2.8%
lower over a long 5.5-year ZIRP span.
See
the glaring disconnect here? The only places where Fed rate hikes
are bullish for the US dollar and rate cuts are bearish is in
futures speculators’ minds! They hold this belief so strongly
that they managed to bid the USDX sharply higher in anticipation of
a new Fed-rate-hike cycle from mid-2014 to early 2015. But during
times of actual Fed rate hikes and cuts, the USDX hasn’t bothered
following this model at all.
This
hard historical precedent of US-dollar trading action compared to
FOMC FFR target changes ought to dispel futures speculators’ false
beliefs. Yet as evidenced by their collective trading they continue
to fervently believe this fantasy they have concocted. This is
utterly baffling, as these elite traders running such extreme
leverage can’t risk having emotions cloud real probabilities. That
can spark big and fast losses.
Yet
just watch. Like clockwork the next time some Fed-hawkish news
catalyst arises, the US dollar will surge on heavy futures buying.
It could be Fedspeak, an FOMC statement, its accompanying dot plot
once a quarter, or a sizable upside surprise on major US economic
data. Traders will again rush to buy dollar futures on their
groupthink assumption that higher yields from Fed rate hikes will
boost the US dollar.
While the psychological pathology here truly lies in the US-dollar
speculators, their kneejerk behavior has a big impact on gold. The
world gold market is pretty opaque, with hard fundamental
supply-and-demand data mostly only reported quarterly or monthly at
best. So gold-futures speculators with their ultra-short-term
outlooks necessitated by extreme leverage must find something else
to watch for their own trading cues.
And
their metric of choice is the US dollar’s trading action. That
sounds logical as well. The US dollar and gold are both currencies,
mediums of exchange. Though gold isn’t used much as a currency
today in practical terms, it played that role exceedingly well for
millennia all over the world. So it’s intuitive to view the dollar
gold price as an exchange rate, much like the dollar-euro and
dollar-yen prices widely quoted.
So
regardless of the US dollar’s drivers, gold-futures speculators tend
to do the opposite when sizable intraday moves arise. When the USDX
surges they generally sell gold futures, driving its price
lower. And often the reason the dollar rallies sharply is some
hawkish-sounding news that suggests the Fed may have to speed up the
pace of this rate-hike cycle. So gold is effectively hostage to
this rate-hike outlook.
Thus
gold prices and USDX levels are generally negatively correlated.
There are certainly exceptions that occur, because gold-futures
trading isn’t gold’s only primary driver. When
investors are
flooding back into gold, their vastly-larger pools of capital
easily drown out whatever the futures speculators are up to. So
gold most often disconnects from the dollar when investors are
buying or selling gold at high rates.
This
next chart compares gold and the USDX over the past decade or so,
since that stock-panic year in 2008. The dollar’s meanderings are
divided between major uplegs and downlegs, with their starting and
ending points highlighted with light-blue lines. The USDX’s gain or
loss in each major swing is noted, along with the time it took.
From a major-dollar-swing perspective, gold is definitely negatively
correlated.
For
the most part, gold rallies when the dollar weakens and vice versa.
Over most of these spans with major dollar rallies or selloffs, gold
usually did the opposite. That’s this dollar-driving-gold
dynamic in action. The red gold line often roughly inversely
mirrors the price action of the blue USDX line. This has even
happened at times when investors are very active in gold, proving
how influential dollar levels are on gold.
As a
professional speculator and newsletter guy, I’m blessed to watch the
market action in real-time all day every day. After decades of
doing that, it’s amazing how often sizable gold action on daily,
weekly, monthly, and even longer scales simply does the opposite of
what’s going on in the US dollar. The lion’s share of the times
gold is moving, it can be explained by a contrary USDX move. The
dollar is a big gold driver!
Naturally the gold-futures speculators fueling most of gold’s
minute-by-minute price action not only watch US-dollar futures, but
understand what motivates the dollar traders to buy and sell. With
this dynamic so deeply ingrained for so many years now, the
gold-futures guys now watch for the same catalysts implying
more or less future Fed rate hikes. So they buy gold on Fed-dovish
catalysts, and sell it on Fed-hawkish ones.
The
gold-futures speculators are zeroing in on what is going to motivate
dollar traders to buy and sell and acting on it immediately.
Doing this instead of waiting for the dollar guys before reacting
really seems to intensify the gold-price impact from news that could
alter the FFR’s likely path. That effectively slaves the gold price
to Fed-rate-hike projections, unless investment capital flows
overshadow gold-futures trading.
And
not surprisingly when a Fed-rate-hike cycle is actively underway,
traders are much more focused on its probable trajectory. That
makes those news catalysts that can alter Fed-rate-hike expectations
way more potent in driving gold price action. When futures
speculators see something they perceive as hawkish, they are going
to aggressively buy the US dollar while aggressively selling gold.
This is really frustrating.
Just
as Fed-rate-hike cycles haven’t proven bullish historically for the
USDX, they haven’t proven bearish for gold! I’ve done a lot
of research work on this front, starting back in late 2015. Prior
to the Fed’s initial hike of this 12th cycle, gold was hammered on
enormous selling. The gold-futures speculators traded as if they
were utterly convinced higher yields would greatly retard gold
demand and weigh heavily on its price.
Trading theses are fine, but they should always be backchecked with
historical data to see if they have proven valid. So I looked at
gold’s performance during every Fed-rate-hike cycle of the modern
era since 1971. I last updated this important research about a year
ago. Contrary to popular belief, gold has
actually thrived
during Fed-rate-hike cycles! Similar to the USDX, there’s a
persistent myth that the opposite is true.
During the exact spans of all 11 previous hiking cycles since 1971,
gold averaged strong gains of 26.9%. That’s nearly an order of
magnitude greater than the stock markets’ gains in the same spans.
Gold rose during 6 of these cycles and slumped during 5. Its
average gains in the majority where gold rallied were a whopping
61.0%! And its average losses in the minority where it fell
were an asymmetrically-small 13.9%.
Gold
tended to perform best if it entered a Fed-rate-hike cycle
relatively low compared to recent years and the Fed hiking was
gradual. Both have certainly proven true in our current 12th cycle,
where gold has powered 24.2% higher since the day before the
initial hike! Go back and read nearly any commentary on gold in
December 2015 other than my
super-contrary
bullish forecasts, and everyone was wildly bearish.
During that 11th rate-hike cycle between June 2004 to June 2006
where the Fed hiked 17 times in a row for 425 basis points, gold
actually surged 49.6% higher in its exact span! That was
despite the Fed more than quintupling its FFR target to 5.25%, far
more extreme in both magnitude and level compared to the current
12th rate-hike cycle. Fed rate hikes certainly haven’t crushed gold
at all, history has proven the opposite!
So
next week or next month when some news inevitably arises that is
interpreted as threatening four more Fed rate hikes in 2018 instead
of three, don’t worry. When futures speculators predictably react
in their usual historically-wrong kneejerk fashion, relax. They
will bid up the dollar hard for a short spell, and hammer gold.
We’ve seen this boring old movie play out countless times, and it’s
not worth fretting about.
Instead of freaking out about largely-meaningless short-term market
noise, keep the big picture in focus. Gold has powered 26.9% higher
on average in all 11 past modern Fed-rate-hike cycles. It blasted
up 49.6% in the last monster 425bp one in the mid-2000s when the
USDX retreated 3.8%. And gold is still up 24.2% cycle-to-date in
our current 12th cycle, while the USDX has fallen a rather-sharp
7.7% so far.
For
all investors and speculators it’s absolutely imperative to
understand the real relationships between Fed hikes, the dollar, and
gold. Actual Fed rate hikes haven’t proven bullish for the dollar
nor bearish for gold for decades! Futures speculators aggressively
trade as if their opposing mythology on this was true, which can
move the dollar and gold on Fed-rate-hike expectations. But these
emotional anomalies are short-lived.
In
our current Fed-rate-hike cycle, the USDX may very well keep
grinding lower until it reaches its strong secular support down
in the low 80s. And before the FOMC finishes hiking, gold will
almost certainly see cycle gains well eclipsing that 61.0%
historical average in Fed-rate-hike cycles where it rallies. So
being long gold and
the stocks of its
miners which leverage its gains are great trades while the Fed
keeps hiking.
At
Zeal we diligently study market history so we aren’t deceived by
irrational herd sentiment. This helps us execute better real-world
trades, actually buying low before selling high. As of the end of
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are very profitable, as all these trades averaged stellar annualized
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The key to this
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The
bottom line is Fed rate hikes haven’t proven bullish for the US
dollar nor bearish for gold, despite the widespread belief. History
has actually shown just the opposite over recent decades. Gold
tends to rally during Fed-rate-hike cycles, while the dollar tends
to slump. Futures speculators seem to be willingly ignorant of this
strong historical precedent, deluding themselves with groupthink
into believing the opposite.
So
whenever news arises that these guys interpret as supporting more
Fed rate hikes faster, they are quick to aggressively buy the dollar
while dumping gold. Their collective trading action temporarily
bends reality to their fervently-held myth. But these short-term
futures-driven anomalies are nothing to fear, as they soon unwind.
If you want to thrive in this Fed-rate-hike cycle, bet with hard
history instead of herd sentiment. |