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Golden Trade Continues To Shine...For How Long?

Sometimes even I get things right. On December 14th, I suggested that investors should be looking at gold for a trade. At that time, gold was $1,163.70 and it bottomed shortly thereafter, launching into its still ongoing rally. Today (being Friday the 24th), gold has closed at its highest price since mid-November, ending the day at $1,259.

This means that gold is up over 8% since my trading call. This compares favorably with a 5% return in the S&P 500 during this time. Lately, however, the stock market has been acting a little tired, especially in the small cap stocks which seem to be peaking. Gold, on the other hand, has ignored this and is actually beginning to pick up steam. So, the question is, what to do now with your gold?

Looking at the above chart for gold, we believe that we have broken through a downtrend. It is, of course, easy to draw these lines however you want, and I could have made it slightly higher so that we are butting up against the trendline. However, I feel that's not the case.

The pullback in the market in early February, followed by a test and then the current strong up move, leads me to believe that gold is breaking through resistance and picking up steam. The fact that the market is getting tired and the rest of the "Trump Trades" are not accelerating confirms this in my mind.

Moving From Trade to Investment Idea

When I suggested gold as a trade, the thesis was simple. Dollar strength and gold weakness until the Fed raised rates, then a reversal. I made this call in December of 2015 and it worked like a charm...It made sense to make the same trade again, and so far the results have been strikingly similar.

However, last year the trade ran out of steam and, as the economy showed it wasn't losing steam, the dollar strengthened further and gold retreated. Shouldn't that be the case this time? Well, let's look at how the dollar is doing.

True to form, the dollar weakened in parallel with the strength in gold. This is natural, as gold is a way for foreign countries to hedge their USD exposure; sell dollars and buy gold if the USD is going lower.

But, looking at the last few weeks, the divergence between gold and the USD has ceased to exist. Instead, you've got the USD trading higher and gold breaking through resistance and starting to accelerate. What?

Is it time, like last year, to take the gold trade off? Or, is something else afoot here? In this writer's opinion, it's time to keep your gold as I believe we are looking at potentially long run for the yellow metal.

What's Different This Time?

First off, I'm a big believer in the cyclicality of markets. They go up, they go down. And, historical relationships tend to work over time. So, I'm not espousing a permanent change in the relationship between gold and the USD. If the USD were to be strong for the rest of the year due to higher US interest rates, I wouldn't want to be long gold.

What I think is different here in 2017 versus 2016 is the global economic and political landscape. There are two major forces at work here, one of which is positive for the USD and both of which are very positive for gold.

First off, the rise of the nationalist parties here in the US but also in Europe is positive for both gold and the USD. As the potential for threats to the existence of the EU come around, the dollar should benefit. In terms of threats, I mean the potential for Frexit, and the reacquaintance of the world with Grexit which is looking increasingly likely. Were either of these situations to arise (and, after Trump and Brexit, who would discount the possibilities?), there would be a massive amount of capital fleeing the EU. The easiest places to go? Dollars and gold.

Now, I'm not saying this is going to happen, but investors would be wise to prepare their portfolios for the possibility. Which should lead to a stronger dollar and stronger gold, like we are seeing.

Secondly, global economies are improving and inflation is coming back. Witness the most recent data out of both Europe and Japan. The world's largest economies are finally getting back on track. And, prices are starting to reflect this trend. This is at once a negative for the dollar and positive for gold.

(On a separate note, this is also very positive for Bitcoin which is a good alternative to gold and is also well positioned as highlighted in last week's newsletter.)

Last year, we had a situation where the US was the only strong economy. We raised rates and the dollar got strong, killing the nascent gold rally early in the year. Fast forward to this year and we have all economies clicking, which should weigh on the dollar (positive for gold being priced in dollars). In addition, we have the rise of nationalism in Europe and major political and socio-economic upheaval in many emerging countries. This too is positive for gold.

In December we recommended gold as a trade. Now, in February, we are suggesting you ride this trade for the foreseeable future.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.