Since July 2007, there have been 138 trading days out of 2,916 where the S&P 500 (SPY) fell more than 2% in one day, or 4.7% of all trading days. On 48 of those days, or 1.65% of trading days, the US Dollar (UUP) was down, too. On 18 of them, or 0.6% of the time, the 10Y Treasury yield (IEF) was up, meaning the bond market was down with stocks down 2% or more. And on only 4 trading days over the last 10 years, or only 0.14% of the time, both the bond market and the dollar were down together when the S&P fell more than 2%.
Two of those four happened in 2008. Since then it has not occurred once until “Volmadgeddon” on February 8, when the VIX spike crushed hedge funds' long volatility and literally wiped out the VelocityShares Daily Inverse VIX Short-Term (XIV). It happened again on October 10.
The two times this happened – stocks down 2% together with bonds and the dollar - back in 2008, gold (GLD) was up over 3.5% on both days. Gold proved to be within a month of a major bottom which it has not even come close to testing since. During Volmageddon though, gold didn’t do much on or around that day. Now it is. For the first time since gold’s major bottom in 2008, the metal is on the move while stocks, bonds and the dollar are all falling together.
It’s difficult to say why exactly gold had such a powerful bull market from 2000 to 2011, but one thing is for certain. It was not because everyone was looking for a “safe haven” for 11 years. The safe haven gold trade has only been a very short-term day-trade phenomenon. It has never been a long-term factor behind gold prices. Gold’s big move over that decade was more closely correlated (though not perfectly) with the dollar index, which reached an all-time low around the same time that the gold bull market peaked in 2011. The dollar index had fallen about 37% from 2001 to 2011. While the dollar index was at its high at the turn of the millennium, gold was at a generational low. So, judging by the last gold bull market then, dollar weakness, not safe-haven-seeking, was behind it.
What about the gold bull market of 1971-1980? That may have been a bit of safe-haven-seeking, but stocks were not in free fall during that gold bull market. They were pretty much flat, so total return would have still been higher in equities than gold. See below.
The 1971-1980 gold bull market wasn’t really correlated with the dollar index either. In fact, from January 1973 until gold topped in January 1980, the dollar index had only fallen 8%, from 109 to 100.
Gold, on the other hand, had skyrocketed over 1,200%, from $65 to $874 an ounce. What drove the 1971-1980 bull mark, or at least what correlated with it the most, was price inflation. Measured by the CPI, price inflation topped the double-digits once in the 1970s and once in 1980, and it was precisely during those inflation peaks that the gold price went ballistic.
So here’s the big question. What if the driving force behind the 1971-1980 gold bull market - price inflation - combines with that from the 2000-2011 gold bull market – a collapse in the dollar index?
Here’s where we come back to the original point. Very rarely do stocks, bonds, and the dollar all fall together with gold rising strongly. If we have stocks, bonds, and the dollar all falling together, in an inflationary environment which we are currently at the beginning of, that is the equivalent of the two correlative forces behind the last two gold bull markets converging together at the same time. On top of that, if all three asset classes – stocks, bonds, and the dollar itself – are falling, gold becomes the de facto safe-haven that mainstream media always insists is the main cause for a rise in gold prices.
Why will stocks, bonds, and the dollar all fall together? First, the equity markets are not going to recover any time soon. There’s not enough money in the system for a sustained climb higher anymore. The money supply has been expanding at an anemic pace for about 18 months now while stocks have kept hitting new highs. While the M2 money supply has not stopped growing entirely as it did in late 2008, the annual growth in the dollar supply has been slower than at any time since 2010, when stocks were still substantially below their all-time highs. Using data from the second week of October 2017 and 2018, this year’s M2 growth has been 4.1%. Going back by the year, the annual growth rates have been 5.3%, 7.3%, 5.9%, 6.4%, 6.6%, 6.4%, 9.4%, 3.8% for 2010. Remember again that back in 2010, stocks were still well below their highs, so there was room for a bid even though money supply growth was slacking off. Not this time.
But if money supply growth has been so slow, why did stocks just reach new highs before the recent fall? The answer appears to be corporate buybacks. They have only just reached new all-time highs themselves.
Source: Yardeni Research
We saw the same pattern in 2007 when buybacks last reached the current peak. It looks like aside from day-trading relief rallies there will be no sustained climb higher in equities from here. That’s over for now. In fact, it's been over since Volmageddon. Stocks have moved nowhere in 2018. There may not be an enormous crash like we saw in 2008 since M2 has been growing steadily but slowly, but it looks more like this current bubble will gradually deflate in the months ahead.
As for Treasuries, even Jamie Dimon of JPMorgan (JPM) has become an outspoken bond bear, with reports out now that he sees 4% interest rates sooner than most. The Federal government will fund its growing deficits at all costs, driving interest rates even higher. There will be no spending cuts as there never are, and the Fed will not cut rates any time soon for fear of looking like it’s capitulating, and so as not to cave in to the pressure of being called “loco” and “crazy” by President Trump. The 35-year bond bull market is over. Interest rates have not fallen on net for over 10 years now, something not seen since the last bond bull market began in 1981. In March 2008, the 10Y hit 3.29, and we just hit 3.26. That's 10 years and 7 months of steady rates.
As for the dollar index, it may climb a bit more until December when the European Central Bank cut off its ongoing bond-buying program, but then it's toast. What has been driving the dollar index higher has been European banks and hedge funds borrowing at artificially – may I say insanely - low rates driven by ECB bond buying, and buying US T-bills currently yielding 2.22%. German 3M bills are yielding -0.67%. That’s a spread of 2.89%. What European bank or hedge fund wouldn't take advantage of that?
This has been driving demand for T-bills, whose yields are still rising despite this. I have speculated as to whether the ECB will actually end its asset purchase program in December, but so far the signals are that they will, especially given ECB President Mario Draghi's latest words reported by CNBC, that Italy should not rely on an ECB bailout if budget plans fail.
Also recently out of the ECB are signals from German governing member Klaas Knot, who hinted to Bloomberg last week that bond buying may end even sooner than previously planned. Given Italy’s “naughty” behavior regarding its deficits, the last thing the ECB wants to do is subsidize more Italian recklessness by buying more of its bonds. It looks like they’ll actually go through with ending the program. If/when that happens, the demand for dollars to buy US T-bills will dry up, pushing rates higher and the dollar lower simultaneously.
For all these reasons, stocks, bonds, and the dollar are set to trend down together. There is not enough liquidity in the banking system to support the continuation of the equities bull market, for now. Bonds have begun a bear market as of 2016, for the first time in 35 years. Nobody younger than 65 has ever traded in bond bear market conditions before, so almost all of us are new to this. The dollar index is on its way down and showed little to no strength during the most recent collapse in equities. Inflation is headed higher. Gold prices are now responding.
Bear markets in commodities can last for decades. Gold for one went 26 years between bull markets. Silver has still not reached new nominal highs since 1980. But when commodities are in a bull market, they move fast and furious. See 1972 to 1974, the years of stagflation from which commodities have since never broken through to the downside. When inflation and recession combine, that's when commodities explode higher and stay there.
Ever since 1980 though when Paul Volcker's Fed finally got control of the dollar, commodities haven't really moved that much on net. If stagflation returns though, the Fed won't be able to control it this time, and it is this asset class that will get most of the gains and keep them. For conservative investors with a long time horizon, the DB Commodity Tracking ETF (DBC) looks very safe, minimal volatility, and plenty of upside.
Disclosure: I am/we are long GLD. 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.