Gold was a contradictory asset over the past two years, but it has certainly regained its stance recently: Gold rallied 10% over the past two weeks as the U.S. regional banking crisis began unfolding.
But, that's after all throughout 2022, when inflation was the market's and the Fed's biggest nemesis, and gold did absolutely nothing. In fact, over that time, it fell along with risky assets, albeit not to the same degree. What's important is gold failed to go up, despite its reputation as the "best" inflation hedge. It was plagued by the increasing strength in the dollar that left it weak on an absolute basis. As gold touches close to its all-time high of $2,000, very close to the high of $2050 back in August 2020, gold bugs are rejoicing. Finally.
Outside of the inflation target, gold tends to shine during times of extreme stress and recession, especially when there is a liquidity crisis looming, the safe haven flows turn to gold. The last few weeks have been a classic repeat of 2008, or close to it, as central banks never acknowledged the risks in the financial system, given their rapid rate rising campaign. But these same banks knew the government or central bank will always be there to bail them out, so why not make some good returns and leverage the system in the meantime? After all, it is not their own money in the first place. Therein lies the true issue with the banking system, no accountability mixed with greed and ignorant investors. This may have been a liquidity event, but it will eventually lead to a credit event.
The system was shaken as this was all about a massive migration of funds from regional banks to money market funds that were guaranteeing a much higher rate of return for less risk, which is never the case. These banks were lazy in raising their deposit rates of return, and they paid a price for it as investors fled. One can guarantee the system as much as one wants, but investors will find a better place to park their funds; you cannot force them to be with a certain bank. Today the U.S. is studying the possibility of insuring all U.S. deposits to the magnitude of $18 trillion. This is more than amusing.
It is bemusing to see such figures thrown about with a blatant disregard for the number of zeros in their communique. We all know the magic money theory has been pushed to the limit, but this is taking it to a whole new level -- not to mention never having a bank control risk in any way ever at all. The U.S. Two-year yield has come back from its highs of 5% and today the market is pricing in about a three-quarters percentage point rate cut by the end of this year. This at a time when inflation is still averaging close to 5% or more on the core side. Inflation operates with a lag but the sticky parts of the index -- like services inflation -- are still quite entrenched into the system. This is the very inflation Fed Chair Jerome Powell has been trying to put back in its bottle.
The Swiss National Bank may have prevented counterparty risk with its role in UBS (UBS) buying beleaguered Credit Suisse (CS) via an arranged marriage, but the bigger issues remain unsolved -- such as how to incentivize banks to lend with all of them fearing for their survival. If the Fed chair stops its crusade against inflation, then we may yet be in for higher-for-longer secular inflation. That could have huge implications for gold and other commodities and U.S. real yields. For now, the jury is out, but gold is doing what it is meant to, finally.
