It was just two weeks ago that the SPDR Gold Trust ETF (GLD) was close to breaking down and heading to lower lows for the year. But since late May, it has staged a significant rally (up each of the last 8 trading sessions) and suddenly GLD is sitting near highs from earlier in the year.
In this article, I will discuss what's driving this momentum in GLD, how there is a perfect bull market setup in place that could result in substantial gains and how I'm positioned to take advantage if there is a breakout in the sector.
The Bull Market In Stocks Is Being Tested
The current U.S. economic expansion that began in June 2009 just hit the 10-year mark and is the second longest in history. By next month, it will become the longest — surpassing the 1991-2001 expansion.
Given the cyclical nature of economic expansions, we have to ask how much more "boom" is left before the bust cycle takes hold?
The current one is already long in the tooth, but there are plenty that believe this growth cycle isn't finished just yet and it will last for another several years. There are many signals, though, that are indicating the expansion could abruptly turn into a contraction in the very near future.
Slowing Rate Of Growth
U.S. GDP in Q1 showed a healthy 3.1% rate of growth in the economy. However, Q2 GDP estimates are quickly being revised lower as there are clear signs of a slowdown.
The U.S. Manufacturing PMI declined to 50.5 in May, which is the lowest level since September 2009. Meanwhile, new orders contracted for the first time in almost a decade as customers delayed purchase orders due to uncertainty with the economic outlook. This weakness in manufacturing will act as a drag on GDP. The fact that it's also showing the weakest growth since the Great Financial Crisis doesn't exactly bode well for the argument that the 10-year long expansion will continue.
There are many factors that are negatively impacting growth in the U.S. economy.
1. The Fed Funds rate has gone from 0% to 2.25–2.50% over the last few years. While short-term interest rates are still extremely low by historical standards, this has been a lackluster expansion and one that has a massive amount of debt in tow. The latter should be the major concern, as ultra-low borrowing rates are the only thing that has kept the U.S. deficit from surging past $1 trillion per annum.
2. The trade disputes and resulting tariffs that are being levied (and threatened) by the current administration aren't intended to hamper economic growth in the U.S. (just the opposite), but it's a fine line as well. Too aggressive and that can have negative consequences, including disruption and uncertainty in the supply chain. Trade wars can also lead to inflation, which is another serious concern.
3. It's possible that some of this is simply an exhaustion of this expansion cycle — i.e. a completely normal ending as this bull has run its course.
Inverted Yield Curve
The greatest signal of a looming recession is being given by the bond market, as the yield curve is now inverted. History has shown that when the yield on the 10-year is less than yield on the 3-month treasury bill, then a recession will occur in the not-too-distant future.
Inevitably, there will be those that say despite the yield curve inversion, "it's different this time" and the U.S. economy isn't about to enter a period of contraction. Time will tell whether that is really the case or not, but at minimum, this should be a worrying signal for investors and the market.
Since January 2018, the stock market hasn't made any progress to the upside. There is a potential triple top occurring in the S&P 500 as the index is having a tough time getting past the 2,900 level. The third attempt failed, and it's imperative that this latest rebound doesn't stall out or the index is in danger of retesting the late 2018 lows. Just from a technical perspective, this isn't the time to be aggressively long until there is more clarity with the near-term direction of the market.
Inverse Correlation Between Gold And The S&P 500
Gold is the direct beneficiary of all of this uncertainty in the stock market, as there is strong inverse correlation between the two. Their respective bull cycles don't occur at the same time. If the S&P is doing well, it's likely that gold is stagnant or struggling to hold form.
There have been instances in the past when gold and general equities rallied in tandem, but there are usually explanations for this synchronicity. For instance, from the early to mid-2000s, the S&P put on a stellar performance, as did gold. The key difference was the run in the S&P was a bear market rally and was occurring after the index lost more than 50% of its value. It was simply getting back to even while gold was up over 200%. Both GLD and the S&P are higher this year as well, but again, the S&P is just getting back to even after its late 2018 sell-off.
If the stock market is about to enter a rough patch, gold will be bought. With the Fed seemingly giving the signal that the next move in rates might be lower (not higher), there is likely anticipatory buying occurring right now in the metal as declining real interest rates, declining economic growth and a declining stock market all make gold the go-to investment. This accounts for some (but definitely not all) of its strength lately.
$100 Billion Surge In Money Supply Ignites Gold
Over time, the stock market always rises in value. Part of this is because the money supply is constantly increasing, as this is just assets keeping up with inflation. Although when it comes to stocks, improvements in productivity and other aspects — that aren't related to money supply growth — can have a positive impact on overall long-term returns.
Gold priced in USD is heavily influenced (long-term) by the growth of M2, more so than anything else. Negative real interest rates and a declining stock market have a positive impact on the metal and can help chart the course, but money supply growth will tell you how high the price should go.
The last two weekly money stock measures released by the Federal Reserve showed a mammoth amount of money supply growth. There was more than a $100 billion increase in M2 from early May to late May. This is far from typical. I believe this is the main driver of the price of gold over the last few weeks. It's worth keeping a watch on the Fed's money stock releases over the next several weeks to see if this growth in M2 moderates at all.
(Source: Federal Reserve)
GLD - The Perfect Bull Market Setup
As I mentioned above, over the long term, the price of gold is ultimately determined by the money supply. In the short term, there can be other influences. M2 has certainly been increasing over the last several years, but that hasn't helped GLD.
Rather, GLD has been consolidating, biding its time, waiting for the bull market in the S&P to run its course. There is a compelling setup as all of this is lining up perfectly. This confluence of events is undeniable: M2 surging, economic growth slowing, inversion of the yield curve, real interest rates possibly declining further as the prospects for a rate cut increase, high valuations in stocks, possible concerning technical picture (triple top) in the S&P and GLD making another attack at breaking above a resistance level that has been its bane for the last 6+ years. If GLD can get through 130, then exposure to the metal will be prudent and profitable.
Over the last several years, GLD has failed to get past this 130 resistance and it could very well fail again. It might be the S&P that is the one that breaks out. That won't change the long-term course for GLD (as M2 is forecasting much higher prices), but it could put it back into consolidation mode.
Over the last several days, GLD has struggled and appears to be topping out. On the daily chart, it hasn't been able to get above its highs from earlier in the year. On the weekly chart, though, the metal closed Friday at a new high for 2019. The weekly MACD is also now in positive territory. There is still momentum and bullish technical events occurring in GLD.
The Course Of Action
I'm certainly not aggressively long general equities at this stage. I'm extremely underweight and I've been positioned like this for a while. At minimum, I'm waiting for the S&P to negate this triple top before I would even think about increasing my exposure. Even then, I plan to tread lightly and be highly selective. This isn't the time for passive investing. This is a market that can't seem to function properly if rates move any higher, which is frightening and is the conundrum that this economy faces (be sure to follow me as I will be discussing this in more detail in an upcoming article).
I believe the most compelling asset class, both short term and long term, is gold. The most profitable way to play this is via the gold mining stocks which are absurdly undervalued and provide significant leverage to the gold price.
One of my favorite names in the gold mining space is Barrick Gold (GOLD). It's well positioned, both fundamentally and technically, and in a rising gold price environment this is one stock that I expect to outperform.
There hasn't been a clear breakout in gold, but it's still been an extremely profitable year in the gold stocks as many are far outpacing the gains in the S&P (which is up 15% year to date). Over the last year, a basket of solid gold mining picks has trounced the average return in general equities. If GLD breaks out, then these mining stocks will move up multiples from current levels and their rate of increase will accelerate.
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Disclosure: I am/we are long GOLD. 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.