Gold and gold stocks have stabilized after forming a short-term low and even
held up well while the US$ index pushed to an 8-month high. Conventional wisdom
would tell us with the US$ index nearing a major breakout, Gold and gold stocks
would be vulnerable to further losses. However, many astute analysts and traders
believe that Gold and the US$ index can rise together and we note that the
trend in the US$ index while important, is not the primary driver of Gold.
Ultimately, as long as Gold's fundamental driver, declining or negative real
rates remain in place, then the fledgling bull market will remain on track.
First, take a look at what I like to call my master chart for Gold's fundamentals.
We plot Gold, the real fed funds rate and the real 5-year yield. We highlight
the major bear markets in Gold which occurred when real rates were rising or
were strongly positive. Since the middle of 2015 real rates have declined and
that explains the sustained recovery in Gold this year.
Although the Federal Reserve could raise rates, inflation is ticking higher
and recent market action
argues that inflation and inflation expectations will rise into 2017. Inflation
metrics such as the sticky CPI and core CPI are showing inflation well above
2% without higher energy prices which could be on the way in the months ahead.
Oil closed the week at a 15-month high and in recent weeks surged above important
moving averages such as the 200 and 400-day.
In other words, the potential coming rise in inflation figures to dwarf a
measly quarter point rate hike. Recall the mid 2000s and the 1970s. Inflation
rose faster than interest rates and so Gold performed well. The Fed raises
rates when inflation rises but the Fed is almost certain to remain behind the
curve and let inflation run. That is bullish for Gold in US$ terms, even if
the US$ index is performing well.
Another thing to keep an eye on is Gold's performance against foreign currencies.
Below we plot Gold priced in a number of different currencies and the corresponding
400-day moving average. Other than in Yen terms, Gold is in an uptrend against
every major currency and remains above rising 400-day moving averages.
Ultimately, the single most important driver of Gold is negative or declining
real interest rates and with inflation poised to rise, real rates are likely
to decline further in 2017. If the US$ index is rising then that certainly
puts some cap on Gold's performance in US$ terms. However, the presence of
negative real rates combined with continued outperformance in foreign currency
terms would sustain the bull market. Moreover, precious metals already experienced
a vicious multi-year bear market. You don't get that kind of buying opportunity
twice but the recent correction in the sector has created a lower risk buying
opportunity.
