SPDR Gold Trust - This Week's Abnormal Behavior And Forward Factors Explained

Summary

• Precious metals and the SPDR Gold Trust security came under pressure this week alongside U.S. equities, failing as a hedge against such risk.
• The catalyst was fear of the Fed and a steeper monetary policy tightening trajectory, which work against both risk assets and gold today.
• The outlook for the GLD security will depend on the development of multiple factors, but I have a base expectation and a list of issues to watch closely, including inflation.

The SPDR Gold Trust (NYSE: NYSEARCA:GLD) came under pressure in the week of Monday February 26 along with gold and silver prices, the U.S. equity markets and bond markets. Not coincidentally, the period also included the congressional testimony of Fed Chairman Powell. Gold investors and holders of the GLD ETF may be confused as to why the security's performance correlated to equities through the tumultuous period. I hope to clear up any confusion, as well as to provide the forward guidance I promised gold relative readers in my relative stock market report post Powell.

GLD Price data by YCharts

The SPDR Gold Trust (NYSE: GLD) declined 1.0% on Tuesday February 27, as the SPDR S&P 500 (NYSE: SPY) dropped 1.3%. The two were down again in unison on Thursday, again as Fed Chair Powell testified. While the alternative asset class of precious metals is often seen as a hedge or diversifier of risk from equity markets, it served no such purpose this past week. The failure was similar to how gold and silver failed as a hedge against equity risk during the stock market correction earlier this year.

The Catalyst for the Positive Correlation

GLD has a beta coefficient of 0.18 (3 years), and so it is normally expected to serve as a risk diversifier against equity investments. However, that is not what it did this week through Wednesday. The catalyst for the positive correlation this week was fear of the Fed, and importantly not inflation.

This week's testimony of the Fed Chair served to raise market expectations for the Fed funds rate, where now four rate hikes are seen as possible for this year, versus three before the testimony. Importantly, the Fed Chair's testimony was interpreted as hawkish and indicative of risk for a steeper Fed monetary tightening trajectory.

That led yields higher, bonds lower, the U.S. dollar higher, U.S. equities lower and gold and silver lower. Equities decreased in value because of concern about a greater cost of capital to corporations, and a higher threshold to economic value creation. Generally speaking, the market feared the Fed might tap the brakes too soon and too hard on economic growth. In so doing, Fed monetary tightening would also serve to strengthen the value of the U.S. dollar. And that in turn, would drive down commodities priced in dollar terms and also relative currencies valued against the dollar. Gold, therefore, drops on both counts, as I reiterate my view that the commodity is also an alternative currency. The SPDR Gold Trust ETF is a liquid security that allows investors to take a position in the price of gold. So as the price of gold declined, the GLD security did as well.

This is Important - Inflation

Importantly, it was fear of the Fed and not inflation that catalyzed the move. Because if inflation was spurring Fed action, because it was out of control or "hyper," well then gold might have served its risk reducing purpose. This is important folks, and it could be relevant soon, so pay attention. If inflation were the concern, then the value of the dollar would likely be depreciating, and probably even if the Fed were acting more aggressively. Inflation, when excessive or out of control, destroys the value of the dollar, and therefore raises the value of gold.

The Outlook for GLD

Does this week's performance tell us anything about the outlook for the SPDR Gold Trust? The answer to this rhetorical question is, somewhat, but much depends on developments for various factors and expectations for those factors.

Multiple factors play roles in the movement of any given security or asset class. More than just one will matter for gold and for the SPDR Gold Trust in the year ahead. However, for now, it appears expectations for the Fed's monetary policy will weigh against gold for the next three weeks into the Fed's March meeting (but see my notes on tariffs and inflation below). Now, I anticipate the Fed's March meeting will result in a less frightening policy statement and dot-plot forecast than the market is currently pricing in. In fact, I think the economic forecasts will still indicate three rate hikes for 2018 come the March meeting, and that would serve as a reliever of the recent pressure against gold. But, 2018 will be a year in which markets will be extra-sensitive to Fed tightening policy, and so gold and silver would have a steady weight against them, all else held equal.

Obviously, there are significant geopolitical factors that offer gold and silver some support. In Syria, there remains risk that the U.S. could come into a situation with either NATO ally Turkey or with Russia. And the North Korea threat continues, where event risk remains relevant. However, the parties involved have more than enough incentive to avoid such confrontation or to mitigate it if it occurs, and so I give the geopolitical factor significantly lower weighting when considering investment in the SPDR Gold Trust today. That could change on a dime, and I'll let you know immediately if it does.

Economic risks to the United States today appear mostly insignificant. While gold bugs and long-term precious metals investors will point to the vast budget deficit and government debt as threats to the dollar and forces for gold, and rightly so, these are not immediate threats today while the economy is humming and while no disruptor of our sanguine state is present. Or is it?

Enter the Administration's import tariffs and trade war… Tariffs like those imposed Thursday by the President are inflationary. They will raise the price of goods that incorporate aluminum and steel, like the price of new vehicles. So, Thursday, shares of Ford (NYSE: F) and other automakers were declining, partly because of pressures on their profit margins, or sales, depending on how they react to the rise in component prices. Inflation, as we said, would serve gold if it develops significantly, and these tariffs are raising that possibility. These latest actions by the President serve GLD and other precious metals investors, there's no doubt about that.

Concluding, it's messy

If this trade tariff issue progresses (hopefully reasonable minds will prevail), and it gains the attention of economists and strategists, it could serve inflation fears and so serve gold and the GLD. Otherwise, investors would anticipate the Fed meeting and the fresh economic forecasts that the market now believes could show a steeper Fed rate trajectory. That weighs against gold and the GLD for the next three weeks, again for as long as the inflationary tariffs do not garner weight. I was not expecting the Fed to raise its trajectory via the dot plot forecasts into Wednesday, though these trade tariffs raise that possibility as well. As a result, after the meeting, I anticipate a relief rally for the GLD security as the Fed lets down expectations and the dollar gives back ground.

Over the course of the year, I anticipate equities should do well, and precious metals and relative securities like the GLD would be negatively correlated to that performance because of possible U.S. dollar strength and demand for risk assets. However, I will be keeping my eye on inflation, because of my expectations for it to eventually gain steam to a greater degree than the Fed expects. Now, given the latest trade developments (they mean a lot to me), I'll be watching more closely for inflation. In fact, these trade developments have caused me to change my view for precious metals to neutral, from negative previously.

As I see factors changing or influencing precious metals and/or the SPDR Gold Trust, I will immediately update investors. Readers are welcome to follow the column here at Seeking Alpha for those updates.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.