Gold as a “devaluation trade” does not add up

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Good morning. Cocoa prices The Financial Times reported: “Analysts say this decline reflects lower consumer demand as a result of higher prices, as well as expectations for a better harvest… Speculators who were riding the rise have recently abandoned their positions, and many of them are now betting on lower prices.” Think about that (and read today’s post) before you dip another wad of cash into that gold ETF. And email us: [email protected].

If gold’s rise is about inflation and the decline in the value of the dollar, why doesn’t the bond market or the dollar care?

The astonishing rise in gold prices needs an explanation, and one of the most popular explanations is that fiscal sanity will never return, inflation will rise and the value of the dollar will fall. The Wall Street Journal Reports That investors

They are looking for ways to protect themselves from the potential repercussions of dysfunctional American politics, including the growing budget deficit and the current government shutdown. This pushes them into non-dollar-denominated assets.

Wall Street pointed to the move as evidence that mounting debt and uncomfortably high inflation are disrupting the outlook for the currencies that underpin the global financial system.

Ray Dalio, founder of Bridgewater and a believer in big debt cycles, agrees with the FT’s thesis Reports:

“When you have such a supply of debt… it’s natural that you turn to an alternative store of wealth, and that’s why we turn to harder currencies,” Dalio said at a conference in Greenwich. “Gold is the most important of these elements.”

Ken Griffin of Citadel, another large hedge fund, agrees. from Bloomberg:

“We’re seeing significant asset inflation away from the dollar as people look for ways to effectively de-dollar, or de-risk their portfolios in the face of U.S. sovereign risks,” Griffin said in an interview with Bloomberg’s Francine Lacqua on Monday.

fair enough. But the dollar’s decline ended in April! It’s been going sideways ever since:

The idea that investors have concluded that the United States will eventually have no choice but to inflate its way out of its massive debt burden also fits strangely with the 30-year Treasury yield, which has trended somewhat sideways for two years. Long-term inflation concerns are not visible here:

There are several ways to resolve the contradiction between the concept of bear trade and the behavior of the dollar and long bonds.

It may be so The “devaluation” view is completely wrong. It’s just “another bullshit narrative,” says Dario Perkins of TS Lombard. “Clearly emerging market central banks were buying gold, to diversify their economy away from the dollar. It wasn’t really a ‘devaluation’. Now it’s a momentum trade. The (gold) market is so illiquid, it only takes a few crazy people to push the price up.” The idea of ​​putting people down “is completely wrong — what can I tell you? If people’s opinions on this argument haven’t changed because of the data over the last six months, they won’t,” says Ed Husseini of Columbia Threadneedle.

Alternatively, you can argue that The world’s disparagement is not limited to the United States, in fact it is less pronounced in the United States than elsewhere.. Gold “is not just a rejection of the US dollar – it is a lifeboat for all fiat currencies,” wrote James Athey of the Marlboro Group. “US 30-year bonds this year have been generally sideways drifting of late but in a gentle uptrend. Elsewhere, the sharper uptrend remains largely intact,” notes Albert Edwards of Société Générale. This chart provides:

You could also argue that the real story driving global investors into gold is not inflation in the US, but… Arming the United States with dollars. Here is Athy:

The United States’ excessive and increasingly questionable use of the US dollar as a weapon has been a huge boost to gold’s appeal. Western central banks have held the vast majority of their reserves in gold, not US dollars, for decades. The emerging market world, by contrast, is now looking to a system where these markets need fewer US dollars to trade, and these markets will be politically beholden to whatever crazy policies the US conjures next, because they do not want to confiscate their reserves.

Adam Posen of the Peterson Institute agrees that gold buyers are not primarily motivated by inflation:

Gold prices are driven primarily by individual investors, hostile regimes (Russia, Iran), and some speculators. It is driven primarily by investors who fundamentally distrust the US government and paper money. And not just inflation. In fact, the value of gold (like cryptocurrencies) to these people is largely due to its lack of correlation with the US macroeconomy and government (and thus not US inflation and the Fed).

There is also room to say so Gold is a tail hedgeIt is not a bet that a decline in the value of the dollar is a likely outcome. In this sense, investors hold gold precisely because they also have a lot of exposure to the dollar and Treasuries. This view has been expressed recently In feet:

However, the bond market is not pricing in the loss of control over inflation. Instead, gold is used as a “back hedge” by investors, according to Francesca Fornasari, head of currency solutions at Insight Investment. She added that the view was “we don’t want (the loss of the Fed’s independence) to be our base case, but we want to have something.”

Finally, one might argue that many investors expect the deterioration to occur, but they expect it to happen I don’t want to be short treasuries now Because of the Trump administration’s stated determination to keep long yields low. Here’s Calvin Tse from BNP Paribas:

Markets don’t want to fight management. The market knows that the administration has a well-publicized goal of keeping interest rates on long-term loans low to support economic activity and households. . . We have argued that the Treasury could keep supply (long-term Treasury) constant during Trump’s term (or even reduce it). . . We see the Fed buying half the net supply of bills (short duration) for the next two years. . . This complements the Treasury’s plan to issue more Treasury bills and thus keep the back end (of the yield curve) under control.

Unguarded point of view? We believe that the gold rally started as a fundamental political event, driven by central banks, but has now become a momentum trade. The reductionist view in its entirety is simply inconsistent with what we see in the Treasury and currency markets.

One good read

Extreme skiing.