The Gold Debate – Where Do Things Stand In The Gold Market?

JSE Gold Index: we have circled the breakout we discussed in October in red. It was followed by a textbook retest, and then it was off to the races for good.

Since South African gold stocks tend to lead US gold stocks near major turning points (see also the original “Canary in the Gold Mine” post from early 2016), we consider this to be a potentially quite significant development.

Apart from signals we get from market indicators one would also do well to ponder a number of recent events and their likely impact on gold prices down the road. In this context one also needs to keep in mind that gold prices will probably lead future fundamental developments.

For one thing, the Federal Reserve’s sudden about-face regarding its policy bias may well end up damaging its much-vaunted “credibility”, despite the fact that it was greeted with great enthusiasm by market participants. It certainly feels as if Fed members are slowly realizing that the central bank is boxed in. It seems “QE” is akin to the Hotel California: you can check in, but you can never leave.

Western central bankers should have known- all they had to do was look at Japan. After all, Japan isn’t on another planet. In Japan they now have QE and ZIRP forever and ever, a scary and inexorably rising pile of public debt, while economic growth is increasingly disappearing into the realm of myth and legend and vast swathes of the population seem to be suffering from depression. Why this didn’t set alarm bells ringing is a complete mystery to us. Our guess is that it was a case of extremely misguided central planner hubris.

Gold is traditionally a major beneficiary of crumbling faith in the monetary authority and we don’t think that has changed. The Fed’s credibility should therefore definitely be of concern to anyone interested in the gold market

Hedgeye cartoonist B. Rich quickly responded: Jerome Powell as Peter Pan, chained to the S&P 500 and lastly in his new role as the Dovefather.

This brings us a few other recent events that are giving us pause (interestingly, we have so far not seen them discussed elsewhere in the context of gold). As Mish reported, a study by the US Department of Commerce has come to the bizarre conclusion that European car imports do indeed pose a “threat to US national security”.

One day earlier, Vice President Mike Pence attended the Munich security conference. After offering greetings from President Trump he waited for applause – and received a rather awkward moment of silence instead:

Not only that, but his attempts to put pressure on the EU with respect to the Iran deal were less than successful (as an aside to this, we are generally on board with most of Donald Trump’s foreign policy efforts and are often disappointed when they are thwarted, but we think ditching the nuclear treaty with Iran was a mistake). Along similar lines, his attempt to persuade Germany to abandon Nord Stream 2 – after which the US is presumably going to sell LNG to the Germans at roughly twice the price Russia is charging – were not exactly welcome either (see once again Mish for additional color).

That there is a rift between the Trump administration and the EU has been obvious for quite some time, but lately it seems to be growing. Clearly the rhetoric is becoming more adversarial, as inter alia evidenced by Ms. Merkel’s speech at the conference. Since the political establishment of the EU is increasingly under threat from its own unhappy voters, we would not expect it to back down when it is confronted with outside pressure.

Normally we ignore geopolitical developments in the context of gold analysis. Empirical evidence suggests that gold price spikes triggered by geopolitical events are invariably given back, i.e., they usually represent short term selling opportunities. However, if it seems possible that monetary and economic policy could be affected, one should pay attention. The report by the US Commerce Department on European car imports indicates that the recent US-EU spats could indeed affect economic policy.

Transatlantic dissension in particular tends to create a bullish backdrop for gold. This was e.g. the case in the late 1960s and early 1970s when the Bretton-Woods agreement fell apart. It was once again a factor in driving gold prices higher in 1987, when the US administration clashed with Germany over the Bundesbank’s tight monetary policy.

With the EU increasingly coming under strain – it is losing its third biggest net payer now that the UK is exiting – the fact that it is a major beneficiary of what is referred to as the Pax Americana is coming into stark relief as well. European citizens with assets to protect are undoubtedly eyeing a potentially weakening security umbrella with concern. While the allies are likely to resolve their disagreements eventually, things could easily get worse before they get better.

Gold investors should keep a close eye on these developments, especially if they end up affecting cooperation between central banks. We say this because Mr. Trump’s trade policies cannot be divorced from currency policy. A weakening US dollar became a major bone of contention in both the 1970s and 1980s and this could eventually happen again.

Despite the fact that gold fundamentals are still not unequivocally bullish, there are signs that investors are increasingly receptive to the idea of buying some gold for insurance purposes. The stock market rout in Q4 2018 has probably reminded some people that having a portfolio hedge may not be a bad idea. There also seems to be growing interest in the battered gold mining sector from value investors. The HUI-gold ratio has begun to trend up, albeit in laborious fashion as you can see below: