For the past few months, we have been bearish on gold. See this most recent note — Gold vs Bonds — for an extensive rationale.
But as that old devil Keynes once said: “When the facts change, I change my mind. What do you do, sir?”
In gold’s case, the “facts” that constitute a game-changer are two:
- The surprisingly horrible U.S. jobs number on Friday.
- Gold’s reaction to it (the message of price).
First up, price action. This chart speaks with no stutter:
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Roughly speaking, the jobs data was frosting on a very nasty cake.
CNNMoney captures the gist:
“The U.S. employment report was simply terrible,” said Marc Chandler, global head of currency strategy at Brown Brothers Harriman.
The May jobs report showed only 69,000 jobs were added to payrolls, less than half the 150,000 jobs forecast by economists surveyed by CNNMoney. The unemployment rate ticked higher for the first time in a year, rising to 8.2%…
“The move in bond markets is even more telling,” said Joe Saluzzi, co-head of equity trading at Themis Trading. “A 1.5% 10-year yield? That’s fear.”
Bond yields have been in record low territory for the past couple of weeks, as fears of Europe’s escalating debt crisis have been building. A report on Friday showed the eurozone unemployment rate at a record high of 11%.
Concerns about slowing growth in emerging markets, including China and India, have also put investors on edge. Two reports out of China Friday morning showed that the manufacturing sector contracted more than expected in May, fueling investors’ concerns that the country may be headed for a hard landing.
On Friday morning I tweeted the following:
The “fire and ice” extremes comment is a succinct version of our full thesis regarding gold.
Basically gold does well in times of crisis and upheaval, whether inflationary or deflationary; in periods of “muddled middle,” e.g. weak growth and shaky maintenance of the status quo, gold does poorly.
Friday’s data was thus a potential “game changer,” confirmed by price, in respect to a broad scenario shift from “weak growth” / “U.S. still recovering” / “Europe will figure something out” to renewed fear of the “ice” in fire and ice, i.e. this situation is really, REALLY bad.
Our gold assessment was further explained last week via reader Q&A in the Mercenary Live Feed.
Within the Feed stream, members can ask us anything they like — on macro events, trade rationales, methodology etcetera.
Below is partial answer to one such question, “Is gold a deflation trade?”
Gold is a crisis instrument. It does well at the macro extremes.
Here is a simple way to think about it:
- In extreme inflationary environments, the value of paper assets is being rapidly eroded, and the value of “stuff” — commodities, infrastructure assets, precious metals — is ramping higher relative to paper. Gold miners can also do well in this environment as the projected value of “gold in the ground” — their proven and probable gold reserves — increases dramatically.
- In extreme DEflationary environments, gold can still do well as “the only alternative currency not subject to a printing press.” Central bankers are scared to death of deflation — in a true downward deflationary spiral, CBs will be “printing money” to no effect because consumers don’t want to spend and banks don’t want to lend. This phenemonon is also known as a “liquidity trap,” or “pushing on string” (because stimulus efforts do nothing). Gold does well here in relative terms, as a form of currency that holds its purchasing power even as all other currencies are rapidly debased. In other words: If the cash in your money market account is rapidly losing purchasing power, due to frantic printing, gold’s nominal price will rise as the value of cash falls.
So, yes… gold CAN be a deflation trade (as can gold stocks, which are leveraged to the price of gold via production reserves). The trouble is, things typically have to get really, really, REALLY bad for gold to become attractive relative to other higher yielding assets.
We can further consider the price action on the GLD weekly chart:
The previous retests of the late 2011 support level were a bad sign. Within the context of an ugly goldilocks environment — in which the U.S. was expected to recover weakly, and Europe was still discounted as a “muddle through” — the odds warned of further gold breakdown and a break of the threshold being tested.
Now, though, with sentiment shifting sharply in the wake of the horrible jobs report — and Europe moving closer to “endgame” than ever before, even as China hard lands — it appears more likely that gold’s weekly / monthly support lows will hold.
Major support levels and trendlines are critical, in part because the entire global macro community watches them for hints, clues and tells, and in part because their violation often comes in conjunction with major sentiment shifts and / or “make or break” type data points.
In other words, it is not uncommon for a market outlook to shift in major ways — e.g. from bearish to bullish — around a key inflection point. (That’s why they call it an inflection point!!)
If you’ll forgive a touch of waxing poetic here:
As the “fear premium” in U.S. treasuries tells us — now harmonized with a chorus from gold — investor perception of the macro environment has shifted from “ugly / unpleasant” to “downright terrifying.”
Europe’s existential crisis, for so long written off with a hand-waving “they’ll figure something out,” is now a living embodiment of the famous Camus quote: “There is but one truly serious philosophical problem and that is suicide.” Europe has to decide — literally, in monetary union terms — whether or not to commit suicide.
The weak but sustainable U.S. recovery, meanwhile, just took a major turn for the worse. Frantic doctors and nurses will now be huddling around the sickbed patient in ICU, debating sharply over whether to pump in more drugs… or rather, how much more they can pump before the patient’s heart explodes.
The icy cold fingers of deflation gripped the market’s throat on Friday, June 1st, 2012. And gold, being an instrument of fire and ice extremes, responded.
This is the outcome in which the compounded fiscal sins of the indebted West overwhelm markets like a black debt tidal wave, and Bernanke et al go “nuclear” in one last hope of avoiding a Global Greater Depression… with gold doing what you imagine it might under such circumstance.
We now have to adjust scenario probabilities accordingly — away from “muddle through” on the U.S. side, and toward “deflation panic” on the global central bank side.
In the past we have tongue-in-cheek referred to “The four horsemen of the apocalypse:” Gold, US treasuries, the U.S. dollar, and the VIX.
These four become dark riders on the storm in the sense that, when you see them all rising at the same time, you know some very, very bad juju is going down.
It ain’t a pretty picture. But it is the picture that gold, and its fellow “horsemen,” are painting now.
Charting a deflationary storm course,
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