The minutes from the December FOMC meeting created a firestorm across the markets this week, which caused rumblings in nearly every market that matters -- from oil to bonds to gold. The virtual blood of many a column inch was not spared as the discussion of this in real time was furious, with everyone attempting to talk their book and, like the Fed, jawbone the market to their desired conclusions.
Such is the state of modern financial writing, but I digress.
I'm long gold. I've been long gold since 1999. I will continue to be long gold until such time as the fundamentals for gold actually worsen. Moment-to-moment price swings are only interesting from a trader's perspective. I learned a long time ago that I have neither the skill nor the temperament to trade gold and gold mining stocks in the current environment. So, for anyone thinking that this article will be just another in a long litany of someone talking his short-term book -- a la Goldman Sachs (GS) -- I have refreshing news for you. I'm not. I am, however, interested in how gold moves day to day and week to week to spot important pivot points.
Click to enlarge images.
Here's the latest weekly chart for gold. Notice anything interesting? I do. Gold has dropped six weeks in a row. That's a rare thing. One might say that implies the bull market is over. One could also say that gold rarely moves down for that long without staging some form of rally. Few things move down for six weeks in a row. So, who's talking their book now? Maybe it's the Fed.
In the last eight years (254 weeks), gold has dropped six or more weeks in a row just 11 times -- that's a 4.3% probability. And, yes, these are exceptional times. Of that there is no question. The action on Friday after a brutal sell-off to $1,626 nearly took gold positive for the trading week. If I were still a trader, I would consider that a statement. It was an exceptionally violent week that had a number of outlier events contained within it, including:
- The end of a calendar and, therefore, tax year when funds and investors were waiting until the last moment to handicap the tax law negotiations in Washington, D.C.
- A major piece of legislation was filed after the market closed on New Year's Eve.
- The FOMC released its monthly minutes.
- Gold's range for the week was nearly $70.
When one stops to think about the sheer size and scope of the variables in play, it actually makes little sense to draw any conclusions about the trading action in gold this week. That's why the headlines are really nothing more than hyperbole. After all of that noise, gold wound up off $3.60 from where it opened on Monday. Does that sound like the beginning of a bear market to you? But that is exactly what we've been told.
What really happened on Thursday and Friday after the FOMC minutes release was that a lot of people who had ridden the bond bubble in 2012 waited to book profits until after the end of the year. The speculative bloom had come off the bond rose, as it were. All the central banks are printing. The fundamentals for long-dated bonds are horrible. We all know this. He who prints the slowest will win the "Currency Wars."
Taking money made in 2012 and getting to cash for redeployment under the new tax rules makes sense for a lot of people. Gold got caught in that crossfire. It's a currency, and dollars were in demand this week. The Fed helped things along by pulling back on credit by $8.9 billion after pumping in more than $50 billion in the two weeks previous -- the first week since the end of October where total Fed credit contracted. Again, trade on what the Fed does not what the Fed says.
Gold trades mostly as a hedge against inflation. Long-term inflationary trends are reflected in its long-term charts. Day-to-day swings are reflected in the shortest-term inflation hedge there is denominated in dollars, the five-year TIPS yield. If there was a one-year TIPS, I'm sure there would be a stronger correlation between it and the daily price swings in gold than the five-year TIPS. Be that as it may, the five-year TIPS is all we have. The above chart shows the yields on the all the TIPS since September.
The Pearson statistic yields the momentum correlation coefficient between two variables. The correlation between price moves in gold -- and its proxy the GLD ETF (GLD) -- and the various TIPS yields show a clear trend. The shorter the timeframe the higher the correlation there is. ~57% correlation is not great, but it is indicative of dependence. What is slightly more highly correlated is the spread between the 5/30 TIPS yields at -60.6%, as is the 7/30 spread at 60.4%.
In the case of TIPS spreads, a wider spread indicates a bias toward short-term inflation, while a tighter spread means the market is biased toward longer-term inflation. So what we had last week was the raw yields rising, which implies rising real rates and slower inflation, while at the same time the spreads were saying that inflation will happen in the short term. Hence the price of gold dropped sharply.
The question at this point is: Where would you be putting your money? If you believe the Fed can stop QE when it wants to without cratering the world economy, then you can short either GLD or the iShares Barclay's TIPS Bond ETF (TIP) with a clear conscience. If you're doing that, you might want to consider shorting the SPDR S&P 500 ETF (SPY) because that will drop as well.
My take is that this week's action was a short-term anomaly that created the opportunity for the bullion banks and the Fed to jawbone the price of gold down while the markets adjusted to the new reality in Washington D.C., which is not that much different than the old reality. I said two weeks ago that the signs of inflation were everywhere, and they are. Remember, gold started 2012 at $1,566 per ounce, total Fed Credit was $2.901 trillion, and the five-year TIPS yield was -0.77%. Today they stand at $1,655.85, $2.896 trillion, and -1.3%. With the 5/30 spread widening out to 1.86%, I would expect gold to follow through early this week and make another attempt at $1,700, especially if the bond markets begin calming down. But nothing is calm right now and it may take time for the mixed signals to clear themselves up.
The U.S. Treasury bond market is the biggest in the world and small movements there can create chaos in the relatively smaller gold market. The bloodbath in the 10+ year bond market this week may indeed be a beginning of a new trend, but those signals have not been confirmed. If anything, it confirms that the Fed is so desperate to get money moving again that it may have floated the threat of ending QE in a bit of double secret reverse psychology.
In the end, everything trades on its fundamentals. When you look at a monthly chart of gold, the fundamentals are still clearly in its favor, regardless of the hype coming from the hedge fund set who are desperate to eke out another 0.5% on their crowded trade du jour. And since it's no longer "Smart Phone Heaven at the Hedge Fund Hotel," (thank you Frank Zappa) otherwise known as Apple (AAPL), I guess it's time to find the next pump-and-dump candidate. It's just not going to be gold.