Gold I: Mixed Message. June was a good month for gold, which made this year’s first half a good one for gold. The price of the precious metal rose 10% from $1,280.30 per ounce at the end of last year to $1,409.00 at the end of last week.
It jumped 9% during June (Fig. 1). It’s now at its second-highest level since 5/14/13, but is still 26% below its record high of $1,895.00 on 9/6/11. It has also rallied strongly so far this year relative to the euro (10%), pound (9), and yen (8). So not surprisingly, gold is up 9% ytd relative to the trade-weighted dollar (Fig. 2). On the other hand, it hasn’t outperformed the S&P 500, which is up 17.3% ytd and 6.9% during June (Fig. 3).
Why this year? And why particularly in June? The solid performances of both gold and the S&P 500 during June and so far this year probably reflect the pivots by both Fed Chairman Jerome Powell and European Central Bank (ECB) President Mario Draghi away from monetary normalization, with recent hints that they are considering going back to ultra-easy monetary policies.
The Fed chairman moved in that direction in a 6/4 speech, while the ECB president did the same on 6/18. Their comments drove interest rates down, with 10-year government bond yields falling around the world. In the US, the 10-year Treasury bond yield fell to 2.00% at the end of last week, the lowest since 11/8/16, while the comparable German and Japanese yields fell deeper into record-low negative territory at -0.33% and -0.13%, respectively (Fig. 4). (See our 6/25 Morning Briefing titled “Lots of Central Bank Liquidity.”)
The lower bond yield in the US is bullish for gold, particularly since it has been led lower by a significant drop in the 10-year US Treasury TIPS yield. Lower bond yields are also bullish for the stock market as they boost valuation multiples, provided that they don’t foreshadow a recession. Consider the following:
(1) There’s no inflation to hedge against with gold. The 10-year US Treasury bond yield has dropped 124bps from 3.24% on 11/8/18 to 2.00% on Friday (Fig. 5). Over this same period, the comparable TIPS yield is down 86bps to only 0.31%, one of the lowest rates since 9/11/17.
The spread between these two yields over that period is down 38bps to 1.69% (Fig. 6). This spread is widely considered to be a proxy for the fixed-income market’s outlook for the annual inflation rate over the next 10 years, so its narrowness suggests inflationary expectations remain low. If that’s the case, then why would the gold price be as strong as it is? After all, gold is widely viewed as a hedge against inflation.
But there is no inflation to worry about. Indeed, on Friday, we learned that the headline and core PCED inflation rates were just 1.5% and 1.6% y/y through May (Fig. 7). The core rate hit the Fed’s 2.0% target only six times since it was publicly set by the Fed at the start of 2012!
(2) Gold is getting TIPsy. The answer to why gold is rallying can be found in the fact that the gold price tends to be highly correlated with the inverse of the 10-year TIPS yield (Fig. 8). In other words, gold does best when the TIPS yield is falling. That makes sense, since both speculators and investors in gold have to pay for storing the metal somewhere. If the inflation-adjusted financing cost is going down, gold is cheaper to store.
(3) Gold diverging from other commodities. In the past, I have often observed that the price of gold seems to confirm the underlying trend in the CRB raw industrials spot price index as well as its basic metals component (Fig. 9 and Fig. 10). However, the price of gold has been diverging from both of these indexes so far this year.
That’s an odd divergence. Is gold signaling that other commodity prices will soon be heading higher? That seems unlikely given the persistent weakness of the global economy. On the other hand, if the US and China strike a trade deal, there could be a “peace dividend” for the global economy, which would boost global growth. However, in this scenario, the price of gold is likely to move lower again.
(4) Copper-to-gold ratio coincides with bond yield. While the TIPS yield seems to drive the price of gold, it is interesting to see that the ratio of the price of copper to the price of gold has been highly correlated with the nominal 10-year US Treasury bond yield (Fig. 11). The same can be said about the ratio of the CRB raw industrials spot price index to the price of gold versus the bond yield (Fig. 12).
This makes lots of sense, though causality runs both ways: A weaker (stronger) copper price signals a bullish (bearish) environment for the bond price leading to lower yields. A lower (higher) bond yield, led by the TIPS yield, tends to be bullish (bearish) for the gold price.
Gold II: Reversal of Fortune. Gold is no longer an inflation hedge because inflation is no longer a problem thanks to the four secular forces of deflation (i.e., the 4Ds: Détente, Demography, Disruption, and Debt), which we discussed most recently in the Morning Briefing cited above. Instead, gold might be a hedge against weak economic growth. Why would weak growth be bullish for gold? Economic weakness tends to inflame destabilizing anti-globalization nationalistic political forces around the world; gold is a refuge from economic and political instability.
The latest batch of global economic indicators shows widespread economic deterioration:
(1) Eurozone sentiment eroding. Especially troubling is the drop in the Eurozone Economic Sentiment Indicator from a recent high of 114.5 during December 2017 to only 103.3 during June, the lowest since August 2016 (Fig. 13). This series is highly correlated with the y/y growth rate of the region’s real GDP growth rate, which was just 1.2% y/y during Q1.
(2) US Q2 real GDP growth estimate lowered. The FRB Atlanta GDPNow model estimate for real GDP growth during Q2 was lowered to only 1.5% (saar) on Friday, as real consumer spending was lowered slightly from 3.9% to 3.7%. That’s still a solid number for consumer spending.
On the other hand, the Citigroup Economic Surprise Index plunged from a recent high of 27.3 on 2/1 to -68.3 during 6/28, virtually matching the year’s low of -68.8 on 4/25 (Fig. 14).
(3) US regional surveys depressed by escalating trade war. Also of concern is the plunge during June of the average business conditions index of the five regional surveys conducted by the FRBs of Dallas, Kansas City, New York, Philly, and Richmond (Fig. 15). This does not augur well for this morning’s national M-PMI release, or for manufacturing in general during June. Debbie and I believe that the weakness was exacerbated by the escalation of the US-China trade war in early May. The ceasefire announced at the G20 meeting could provide at least a temporary boost to the US and global economies, as discussed in the first section.
Bitcoin: Embezzelcoin. In late 2017, when bitcoin was soaring toward a record-high price of $18,961 on 12/18/17, a distant relative asked me what I thought about the cryptocurrency (Fig. 16). He had bought one bitcoin when it was around $4,000 in mid-2017. I said it reminds me of digital tulips. “What do you mean?,” he responded. He is a Millennial who had never heard of the Dutch Tulip Bubble from 1634-38. I explained what happened back then and noted that the bubble was mostly confined to Amsterdam, whereas the bitcoin bubble is global.
Of course, some bitcoin fans believe that bitcoin has a legitimate role in a portfolio as a hedge against the madness of central banks. I concede that point. However, as we saw last year, it can crash, which is what it did on its way back down by a gut-wrenching 83% from the high of $18,962 on 12/18/17 to a low of $3,224 on 12/14/18. But now, it’s back up to $12,356. It certainly is volatile and hardly a stable store of value, which makes it a very poor candidate to replace more stable forms of money.
Some of this volatility may be attributable to the illegitimate uses of bitcoin. I’ve noticed more news stories this year about hackers planting ransomware on the computer systems of small city governments in the US. They successfully extort tens of thousands of dollars in exchange for the software key to unlock the frozen computer systems. Payment has to be made in bitcoin.
In June, Riviera Beach, a city in Florida, paid hackers $600,000 in bitcoin with the hope of having its systems restored. Also during the month, Lake City, Florida facing a ransomware demand, authorized the payment of $490,000 in bitcoin to a hacker in order to regain access to its phone and email systems. At the end of the month, the village of Key Biscayne confirmed it had been hit by a cyberattack, though it wasn't clear if it was related to ransomware.
Cities and small businesses are becoming more popular targets for hackers, who recognize frequently unsophisticated systems. According to FBI estimates, there were 1,493 ransomware attacks in 2018, with victims paying a total of $3.6 million.
In my book Predicting the Markets (2018), I wrote:
“I’m particularly intrigued by the impact of bitcoin and other cryptocurrencies on our monetary system. Blockchain, the software that runs these digital currencies, is allowing banks to eliminate clearinghouse intermediaries in their transactions and to clear them much more rapidly. Smartphone apps allow consumers to use these digital devices to deposit checks and make payments. These innovations could reduce employment and bank branches in the financial sector, much as Amazon is doing in the retail space. Central bankers are scrambling to understand the implications of bitcoin and blockchain. In time, central banks likely will incorporate these technologies into their operations, perhaps spawning bitdollars, biteuros, bityen, etc.”
“Libertarians might long for a day when central banks are replaced by a monetary system based on a digitized currency that is unregulated by governments. I doubt that the central monetary planners will allow that to happen. But who knows? Technology has disrupted major industries. Maybe it will disrupt central banking!”
The International Monetary Fund (IMF) is studying cryptocurrencies. The 6/27 IMFBlog is titled “Five Facts on Fintech.” It reviews the findings of a report titled “Fintech: The Experience So Far.” Based on the IMF’s research, countries generally foresee the emergence of crypto assets backed by central banks. The study surveyed central banks, finance ministries, and other government agencies in 189 countries. More specifically:
“The survey reveals wide-ranging views of countries on central bank digital currencies. About 20 percent of respondents said they are exploring the possibility of issuing such currencies. But even then, work is in early stages; only four pilots were reported. The main reasons cited in favor of issuing digital currencies are lowering costs, increasing efficiency of monetary policy implementation, countering competition from cryptocurrencies, ensuring contestability of the payment market, and offering a risk-free payment instrument to the public.”
Increasingly, at the top of the list for the central bankers is the need to improve cybersecurity in the payments system. Banning cryptocurrencies that are not officially backed by central banks undoubtedly will be considered. Whether this is even feasible is a matter for future discussion.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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