After hitting $2050 in March, almost close to the previous August 2020 highs, Gold has now fallen back down below $1900, down 7.5%. With all this talk about inflation and Europe caught up in the midst of a war, one would imagine the Gold price to rally a lot more but it has not. So, what's going on?
After the excess returns of 2020 and 2021, investors have gotten used to doubling or even tripling their money in their investments in a few months. They got used to trading racy non profitable tech names and NFT's including Bitcoin, and Ether. All risky assets labelled as inflation hedges and de-correlated assets. After the Fed pumped $5 trillion in expanding their balance sheet, buying everything from ETFs (LQD) to (HYG) and Treasuries, all that money got circulated back into all risky assets.
At the time, fundamentals were quoted, but really the fundamentals only took the names so far. It was the rush of liquidity that boosted aggregate demand across the board as money supply increased massively, inflating all asset prices. But sometimes it is not about making 40%, 50% or 100%. It may just be about preserving profits or capital for that matter. That is where we were at the end of last year when Gold was the only asset to own, given the risks of slowing growth and heightened inflation coming into this year. This was before the war on Ukraine.
Through the end of Q1, Gold was up 10% vs. other assets down 80%-90%. A lot of people may be "bored" with Gold but it did exactly what it is meant to, preserve capital on an inflation adjusted basis when the world was falling apart!
Sometimes being boring is exactly what is needed as an investment when the global economy is going through a slowdown and inflation is moving from 4% yoy to as high as 10% yoy. An asset outperforming relatively is still as important as one that beats on an absolute basis as well. But Gold, too, has its own drivers ranging from central bank holdings, dollar currency to the US bond yields. Other than its correlation with real yields, it does tend to fall if the dollar rallies.
The Fed
As the Fed is one of the few central banks now bent upon raising rates as they clearly realize they are clearly behind the curve on inflation, the dollar is rallying aggressively vs. most currencies, especially the yen and yuan. The latter currencies are collapsing as their central banks are still "easing" as opposed to tightening, despite how high inflation is as their system has got too much debt and so it is not possible for them to raise rates as much as they would like to.
Judging by the CPI yoy rate and Fed Funds rate, one could argue that the real interest rate should be closer to 5%+. We are nowhere close to that even as the Fed just lifted the rates by 25 bps to 0.5%. It is for this reason all the Fed members are talking hawkishly as they realize that something needs to be done but they also fully well know that they cannot raise rates by so much.
The market participants have become awfully complacent over the past decade as the Fed has always been there to bail them out. Any crisis that came saw the Fed bump up their balance sheet, printing even more via QE! But this time around the Fed has its hands tied as inflation is already spiraling out of control, if they were to print more, that would seal the deal to stay in permanent stagflation.
The fact of the matter is that the new generation of traders graduated from the school of Modern Monetary Theory (MMT) have not been around to know what inflationary markets feel like. The US central banks are running a huge experiment, following the path of Japan, which has not failed them so far. But that does not mean it cannot come back to haunt them in the future.
Liquidity has been one of the main drivers of all asset prices over the past decade. But this liquidity is now coming to an end as central banks realize they need to raise rates fast enough now to cool off the economy in the short term lest they are unable to tackle the next crisis. This is what is plaguing the markets right now. Gold too, even though it is relatively outperforming, can see an unwind as all assets get sold down. The system is too leveraged and the old mantra of TINA (There is No Alternative) logic is now falling apart as sometimes it is better to be in cash as there really is no place to hide.
