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Summary

  • Tune out "China's demand drop".
  • Tune out Ukraine style crisis hedge talk.
  • Interest rate spreads are among the most important macro fundamentals for gold.

Excerpted from Notes From the Rabbit Hole:

Gold's Macro Fundamentals

(click to enlarge)

This spike in short-term yields (2-year shown) is what harpooned gold last week and finally got it under control.

(click to enlarge)

More importantly, this spike in the 2-year vs. the 30-year really hurt gold.

These spikes predictably came as the FOMC successfully managed to get the market thinking about an end to the damaging Zero Interest Rate Policy, ZIRP.

Interlude

Yes, it is that time again when the letter writer veers off course into a brain dump. You, dear long time subscriber, have heard this before. But for newer subscribers I feel a point needs to be made so that your expectations of this market report are well in line with its raison d'être.

This is not a "go gold!", "got gold?" style pump house. Simply stated, I would rather live in a world where I do not feel gold is a necessary asset class. I would rather live in a world where bureaucrats were not in control of interest rate functions and hence, to some degree in control of financial markets.

Under this interest rate manipulation, the concept of saving has been utterly torn apart in the United States via the now 5+ year old ZIRP. If you do not speculate, you do not profit. The problem is that the risks in speculation are rising with every lurch higher in the stock market and junk bonds, to name two of the primary beneficiaries.

So it's everybody into the (risk) pool and everyone foolish enough to depend on savings … screw you. So I [omitted, not for public consumption] because I continue to unwaveringly believe that this big macro operation, going in one form and degree of intensity or another since 2001, is little more a than racket to be unwound.

But if the moment were to come when I feel we really are on the right track - and folks, withdrawing ZIRP [could] theoretically at least be considered one component of "on the right track" - this market report would simply move on from the precious metals sector because frankly, I find it a strange place inhabited by some strange people.

The problem though is partially represented by the distortion built into this chart …

(click to enlarge)

Something is just not right here. Long into an economic recovery and even longer into a bull market in stocks the Fed Funds rate (FFR) is still pinning T Bill yields to the mat. Now, the Fed Chief babbles about a rate hike out in 2015, "that type of thing". Gold then reverses its ascent (it was ripe, given the Ukraine hype coming out of the gold "community") on the implications of rising short-term yields.

Using the 2003-2007 bull market as a template, the FFR should have begun to rise in 2010. Now it is 4 years later than that and the Fed is talking about a rate hike out in 2015, "that type of thing". Please. They are playing poker against the market and for now the market is not calling any bluffs.

Back on the Fundamentals

So last week we had a group of interest rate manipulators meet for 2 days and then a press conference by the group's leader. She "you know" intimated that the ideal timing to begin phasing out ZIRP would be approximately "you know" sort of like maybe 6 months after QE3 is entirely tapered. "You know", if the economy is still strengthening then; that sort of thing.

Okay tell me now, who knows what the economy will be doing then? As things stand now, last week was a negative for gold, which was in need of a correction. But the key question going forward will be whether or not these negatives will endure or go back to business as usual as FOMC day fades to background?

(click to enlarge)

So the long-term/short-term interest rate fundamental dropped to its lowest point of the gold bear market last week. What can we conclude from that?

  • Gold's fundamental underpinning took a hit.
  • When measuring the length of the sideways channel on the yield spread, we note that gold may have already discounted this drop as its price is much lower than it was in summer of 2012 when the spread first declined to 80.
  • The yield spread, driven down by a jawbone and a lot of market emotion and media hype last week, is at a potential bounce point.

So fundamentally speaking, gold bugs want to see last week's hysterics fade pretty quickly and by extension, the spread hold the support area (notwithstanding a day or two of down spiking for good measure).

If the market comes to believe that the Fed means business on the Funds Rate and 2, 3, 5 year yields continue to rise relative to long-term yields, it would be bearish for the price of gold. I make the distinction between "bearish for the price of gold" and "bearish for gold" because price is a reflection of the value assigned to gold at any given time.

For as long as it lasts, a phase where the market perceives itself to be under the sound monetary stewardship of the Fed - regardless of sustainability - would be gold price bearish.

Of course last week may have been a flash in the pan, as the Fed got the respect it always seems to get from the market during the ongoing phase of stock mini mania and economic mini revival. There are other phases you know, when the market gives them the finger. That is out in the future.

Let's watch the dust settle on the interest rate front and evaluate weekly.

Postscript (current, 3.25.14)

So tell me, what was China doing late last week and early this week as gold got harpooned? Did gold suddenly decline because of the much hyped "China demand drop"? Did supposedly massive physical demand suddenly dry up on the spur of a moment? There's always a seller on the other end of that demand you know.

Ukraine hyperbole unwound and that was expected to take something off the top. But chasing "funnymentals" like China, physical demand (vs. COMEX shortages) and Ukraine around is what got the gold community in trouble in the first place.

There is no debate, real interest rates jumped last week and gold got clobbered. There are other key fundamentals as well. Unfortunately with the media just pumping out story after story, it is no wonder people get so confused.

Source: Gold's Macro Fundamentals