Gold Untethered to Inflation and Fed Money Machine

The 2.6% rise in April food prices was the largest monthly surge in 46 years! On queue, some forecasters blamed it on the Money Supply, Government debt and the Trillions of dollars our Central Bank (Fed) created out of thin air. Soaring grocery costs pale in contrast to the broader trend in U.S. prices, which fell 0.8% in April, the largest one-month decline since the 2008 Great Recession. While the Fed’s digital printing press is setting new speed records, many naively misinterpret Milton Friedman’s monetary theory, concluding that a surging money supply causes inflation. With the persistent decline in currency turnover (velocity) in our economy since 1981, it doesn’t matter much how fast money grows or how much funny money the Fed prints. Furthermore, food is not a major part of the average consumer budget, at less than 10%. In fact with the Covid curtailment of going out to eat, which was half of the average food expense, the cost of eating has fallen despite grocery prices surging. Consumer price inflation has a low correlation with inflating of money supply and  rising food prices are only due to the quarantine. When people were forced to eat at home there was an enormous shift in types of food bought and sourcing. Hoarding has also boosted prices in this age of uncertainty. Costco, Walmart, Amazon and a plethora of home delivery services have taken over. As the masses return to travel and leisure post Covid concerns, food inflation will then normalize. The 8 to 10% of the household budget spent on these inflating food items is overwhelmed by the other 90% of consumer budget items that have among the lowest inflation rates on record.

If not for the Fed debt inflation, all consumer prices would be deflating as never before. Since the floating currency era began in the 1971, the Fed had increased money supply modestly to accommodate a growing economy, until 2009. When inflation rose at a record pace in the 1970’s and then crashed in the 1980’s, the Fed was not printing money. However, in 2008/2009 during the Great Recession, the Government and the Fed threw caution to the wind to battle a deflationary collapse of the US and Global economies. Higher inflation has become a desired goal for the past 12 years. As can be seen here, no matter how much debt the Government borrowed from itself, no matter how many Trillions the Fed imagined out of thin air, inflation did not rise. Since the end of February, the Fed has added $3 Trillion to its portfolio, allowing the US Government to borrow and spend as much as it can agree upon. This money will never be repaid and will continue to rise long term, but it doesn’t cause consumer inflation. Rapid debt borrowing and Fed printing press Trillions are efforts to stave off a panic deflationary implosion. The Fed knows that debt leverage is so enormous that allowing a massive Depression and a tsunami of bankruptcies to manifest without a safety net would crush the financial system and create a potentially dystopian future. The “don’t fight the Fed” mantra is THE major reason to bet on a stock market that will not collapse. Should any 2020 panic send stock values below the March levels where Governments and Central Banks have drawn their line in the sand, then hope would be lost in a system that relies upon psychological confidence in a non asset backed currency system. That’s the caveat emptor, but we are not going to fight the Fed.

Why has Gold held up well during this era of low inflation? Has the printing of Trillions of funny money made this precious metal a store of value? Historically, Gold is a hedge against inflation, moving in the same direction as the consumer price index. The Gold and inflation swings were powerfully linked in the 1970’s as the US dealt with the currency shock of leaving the Gold standard. When inflation cooled in the 80’s and 90’s, so did Gold. As the real estate inflation and mortgage bubble expanded and then blew up in 2008, Gold began shooting higher without the usual consumer inflation trend that typically accompanies such moves. All inflation indices have remained subdued now for over 20 years near historically low rates and yet Gold continues higher. Perhaps most surprising is the rise in Gold in 2019 while the Fed was shrinking its balance sheets (money supply), inflation and the US economy were slowing.

Aside from money supply and inflation, the other causal factor affecting this precious metal is often the inverse relationship with the US Dollar. With most global commodities priced in Dollars, to the chagrin of Russia and China, it’s logical that a devaluing Dollar inflates Gold. A lower Dollar makes imports into the US cost more and correlates well with a general rise in inflation. When the US forced the world off the Gold standard in 1971, the Dollar collapsed while inflation and Gold soared. Since the 70’s, the Dollar moves have been more contained, but Gold and the inverted Dollar index (below) continued to move in unison until 2018. For the past 2 years Gold has moved significantly higher from the $1100’s to the $1700’s despite the disinflationary trend of a higher Dollar (or lower inverted Dollar) and low inflation. Conversely, Gold has weakened along with the Dollar since early April as they continue to move in sync, contrary to its traditional relationship.

Worry over the economy, the Fed printing Trillions, Dollar stability and inflation have increasingly been disconnected from Gold prices recently. What we do pay more attention to are indicators, sentiment and hedger commitments when discerning the multi week or multi month direction in Gold. The old multi year Bear market in Gold ended at the close of 2015 under $1100/oz. and the current Gold Bull was confirmed in June 2019. By watching the overbought and oversold extremes in futures trader consensus and managed money holdings we have been able to catch important inflection areas for trend changes. Currently Bullish sentiment of Gold traders is approaching extreme overbought optimism with negatively diverging momentum. For Bulls there is a clear Flag formation portending a strong move higher soon. It’s possible, but we would be concerned of false breakouts with so much consensus in buying all the metals. Missing a potential upside breakout and waiting for a more extreme overbought level to Sell or Selling a breakdown of the recent trading range would be our preferred strategy. The Dollar’s more recent unified relationship with Gold has been Bullish the past 2 weeks as the Dollar has strengthened. The next move in the Dollar may hint what’s next for Gold. While strong inflation should also help Gold, inflation is currently very weak with so many businesses without customers. We expect the $1500’s in Gold to offer a higher confidence entry to enter this market.


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