The Case For Gold Is Weak


October 4, 2016, 5:00pm EST

Stocks continue to chop around as we head into the big jobs report this week.  But the dollar has been a mover today, so has gold.

Let’s take a look at the chart of gold.  It has broken down technically.

You can see the longer term downtrend in gold since it topped out in 2011.  And we’ve had a corrective bounce this year, which was contained by this descending trendline.  And today we broke the trend that describes this bullish technical correction (i.e. the trend continues lower).

A lot of people own gold.  And it’s a very emotional trade.  Whenever I talk about negative scenarios for gold, the hate mail is sure to follow.

We’ve talked quite a bit about the drivers of the gold trade. I want to revisit that today.

Gold has been a core trade for a lot of people throughout the crisis period. When Lehman failed in 2008, it shook the world, global credit froze, banks were on the verge of collapse, the global economy was on the brink of implosion—people ran into gold. Gold was a fear–of–the–unknown–outcome trade.

Then the global central banks responded with massive backstops, guarantees, and unprecedented QE programs. The world stabilized, but people ran faster into gold. Gold became a hyperinflation–fear trade.

Gold went on a tear from sub–$700 bucks to over $1,900 following the onset of global QE (led by the Fed).

Gold ran up as high as 182%. That was pricing in 41% annualized inflation at one point (as a dollar for dollar hedge). Of course, inflation didn’t comply.

Still eight years after the Fed’s first round of QE (and massive global responses), we have just 13% cumulative inflation over the period.

So the gold bugs overshot in a big way.  We’ve looked at this next chart a few times over the past several months.  This tells the story on why inflation hasn’t met the expectations of the “run-away inflation” theorists.

This chart above is the velocity of money. This is the rate at which money circulates through the economy. And you can see to the far right of the chart, it hasn’t been fast. In fact, it’s at historic lows. Banks used cheap/free money from the Fed to recapitalize, not to lend. Borrowers had no appetite to borrow, because they were scarred by unemployment and overindebtedness. Bottom line: we get inflation when people are confident about their financial future, jobs, earning potential…and competing for things, buying today, thinking prices might be higher, or the widget might be gone tomorrow. It’s been the opposite for the past eight years.

When this reality of low-to-no inflation and global economic malaise became clear, even after rounds of Fed QE, there were a LOT of irresponsible people continuing to tout gold as an important place in everyone’s portfolio, even at stratospheric levels.  People bought gold at $1900 and have since lost as much as 40% on the value of their investment – an investment that was supposed to “hedge” against inflation.

On that note, today the IMF downgraded U.S. growth estimates for the year from 2.2% to just 1.6% — in a year that many were initially expecting to be a good year, nearing trend growth levels (3%-3.5%).  So eight years from the inception of the Fed’s extraordinary policies, the case for gold remains weak and an investment with more risk than reward.

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