GLD: Flight To Safety

Thesis Summary

Gold prices (GLD) have broken out in recent weeks, and I see this as a very strong indication that we are in a new bull market.

Interestingly, Gold has been rising in the face of higher real yields, which is strange. What could be the cause of this?

There’s still a strong debate going on between those who see an imminent credit collapse and those who see persistent inflation over the next decade.

In my last article on gold, I talked about how it could serve as a great hedge against the demise of the dollar, and an inflationary event reminiscent of the 1970s.

Some analysts, however, believe that what is coming next is a deflationary event, as the economy enters a recession.

The way I see it, though, gold can act as a great portfolio hedge for both of these scenarios, and we are seeing evidence of this as markets are selling off.

Something Strange Is Going On

Gold has been on an absolute tear recently. The yellow metal is up over 10% in the last 17 days.

This kind of move in gold is very rare, and it could be signaling something big is about to happen.

This move in gold has been unusual in another way, though. We are seeing gold rise together with real yields.

For a long time, gold has held a negative correlation with real yields. In the chart above, we see the gold price and the Treasury Inflation Protected yield, inverted.

Typically, when real yields are low and even negative, gold tends to perform well. Gold prices tend to decline When yields rise, like in 2012-2016.

This relationship has been broken since the Ukraine war.

So, what has changed since then?

Gold Is Back In Fashion

Undoubtedly, the increase in geopolitical risk has played a role in gold’s new appeal. Gold is back in fashion, and everyone seems to want a piece.

Of course, it is no secret that the BRICs have been accumulating gold and working on a gold-backed currency:

Recent research suggests that “BRICS and Friends” gold holdings have now surpassed those of the US.

On top of that, retail investors now seem to be piling in, too. In a noteworthy turn of events, Costco (COST) began offering consumers gold bars at the beginning of the month. And according to reports, these were selling out at a fast rate.

With rates climbing and stocks down, it appears that a lot of investors are now seeing Gold as the only good hedge against a credit collapse or perhaps inflation.

Inflation or Deflation? Who cares?

The inflation and deflation debate still rages on. The data over the last few months has shown a clear disinflationary trend. A lot of the COVID imbalances seem to have been corrected.

However, in more recent weeks, we have seen TIPS tick up, which could be an indication that inflation is not over:

There are certainly a lot of reasons why inflation could be stubborn, at least in the long-term. Onshoring, deglobalization, commodity shortages, and record fiscal spending just to name a few.

More immediately, there are also those who see a credit event/recession likely, which would probably trigger a deflation. There are also some good arguments here, such as the impact of higher rates or even the unwinding of the Japanese carry trade.

I’m not here to discuss the merits of these but to say that, in either case, gold is a great addition to your portfolio.

Of course, we are all familiar with how well Gold did during the inflation-ridden 70s and 80s.

On the other hand, I would argue that Gold strongly outperformed leading up to and following the GFC, which many people are drawing comparisons with today.

Firstly, we can see that gold kept rallying even as the SPX in 2008 began to top.

More importantly, though, we can see that Gold fell by “only” 34% from its high to its bottom following the GFC, while stocks experienced a 50% decline. Furthermore, Gold experienced a much faster recovery reclaiming its highs while stocks were still bottoming.

Technical Analysis

Maybe the fourth time’s a charm?

Gold has challenged the $2000 area three times since 2019. Perhaps this time could be the one. From a technical perspective, it’s worth mentioning that we are close to breaking out from a bull flag we have been forming since the recent top.

Also, we can see that Gold found support at the 200-week MA and has now sliced through the 50-day MA.

Now, zooming into the daily chart on the SPDR® Gold Shares ETF (NYSEARCA:GLD) I see us as having completed a wave 2 inside a larger wave V.

This means we could now be ready to rally in wave 3, which should hit the 1.618 ext shown in the chart at $249.

In the more immediate term, the RSI is overbought, and we should see a corrective retracement, probably a retest of the bull flag trendline and the daily MAs.

This would provide us with an ideal point in terms of risk/reward.

Risks

Though I think gold can do well in both an inflationary and deflationary scenario, there are some risks investors should take into account.

For one thing, if the economy does enter a deflationary recession, gold could sell off, at least initially, and investors need to be prepared for that.

If there was a credit event, then the dollar would likely rise, which would be bearish for gold.

Alternatively, there's also the possibility that, this time around, investors might pick other assets over gold an in inflationary event. Perhaps, short-dated bonds, or even Bitcoin (BTC-USD).

Final Thoughts

A lot of investors are panicking with the recent sell-off in equities and rise in yields. If you are also concerned, then increasing your allocation to gold is an easy way to diversify your portfolio and protect yourself from the risk of inflation and/or recession. I expect gold to do very well in the coming months and probably in the coming years.

Macro moves markets, and this is what I do at The Pragmatic Investor

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