Gold continues to get pummeled in terms of a strong dollar. The dollar is one of its chief competitors and bonds denominated in the USD now sport fat yields. Gold typically does best when investors believe prospective real bond yields are too low. Recall gold prices soared alongside Treasuries in mid 2020 as the Fed slashed rates to zero. This dynamic has shifted into reverse.
Many investors are having a hard time reconciling gold’s reputation as an inflation hedge with its dismal performance in recent months. Even as we’ve seen near double digit annual bounds in the CPI gold prices have sunk by double digits. This cognitive dissonance simply flows from a faulty assumption … that the CPI is an index of inflation. Let go of the invalid premise and it all starts to make sense.
The inflation now reflected in the CPI has been happening for years, capped by a final surge in 2020. And gold prices have responded dutifully. As we pointed out a few weeks ago, deflation has taken center stage. Consumer prices are near the end of the price inflation bucket brigade … once inflation is making headlines the early birds have already gotten the worm.
But how does that help us to anticipate what happens next? Deflation – and by that I mean an appreciating currency – is in force. But it has not yet made the headlines. Most of the financial world remains obsessed with inflation, as it watches its exhaust fumes in consumer price measures. With yet even more dollar-supportive monetary tightening in the pipeline, we don’t yet know, but it’s unlikely the system can sustain yields across the curve nearing 4.5% for long. Just for instance how long do you suppose housing prices can hold up with over 7% mortgage rates, after having been priced for years with rates under 3%?
SS thinks a turn could come at any time, having pegged the beginning of this quarter with about a quarter’s leeway. Gold has been a pain trade for investors who do their accounting in US dollars, and we have no crystal ball to tell us in advance the exact date that will change. But we can be prepared for when it does. Accumulating deflation will break something as dollar denominated debt rises and becomes unserviceable somewhere that will catch the financial world’s attention, and prompt the Fed to reverse its tightening program and go into deflation fighting mode. We will know it when bond prices break out of their practically ruler-straight downtrend (below). Gold will confirm by following suit. When the turn comes, though, it will have a long way to run.