The major long-term driver of the gold price is confidence in the official money and in the institutions (governments, central banks and private banks) that create/promote/sponsor the official money. As far as long-term investors are concerned the gold story is therefore a simple one: gold will be in a bull market when confidence in the financial establishment (money, banks and government) is in a bear market and gold will be in a bear market when confidence in the financial establishment is in a bull market.

In real time it often doesn’t seem that simple, though, because on a weekly, monthly or even yearly basis a lot can happen to throw an investor off the scent. However, the risk of being thrown off the scent can be reduced by having an objective way of measuring the ebbs and flows in the confidence that drives, among other things, the performance of the gold market. That’s why I developed the Gold True Fundamentals Model (GTFM). The GTFM is determined mainly by confidence indicators such as credit spreads, the yield curve, the relative strength of the banking sector and inflation expectations, although it also takes into account the US dollar’s exchange rate and the general commodity-price trend.

An alternative to objective measurement is to rely on gut feel, but gut feel is notoriously unreliable in such matters because it is, by definition, influenced by personal biases. For example, it will be influenced by “projection bias”. This is the assumption that if you perceive things in a certain way, then most other people will perceive them in the same way. Projection bias plays a big part in a lot of gold market analysis. The market analyst will observe central bank or government actions that from his/her perspective are blatantly counter-productive, and go on to assume, often wrongly, that most market participants will view the actions in the same way.

Another alternative is to assume that gold’s fundamentals are always bullish and therefore that any large or lengthy price decline must be the result of a grand price-suppression scheme. Given its absurdity it’s amazing how popular this line of thinking has become in the gold market. Then again, it’s a line of thinking that has been aggressively promoted over the past two decades and has a certain emotional appeal.

Due to the effects of market sentiment the gold price occasionally will diverge from its ‘true fundamentals’ (as indicated by the GTFM) for up to a few months, but ALL substantial upward and downward trends in the gold price over the past 15 years have been consistent with the fundamental backdrop.

Does this invalidate the idea that manipulation happens in the gold market?

Of course not. Every experienced and knowledgeable trader/investor knows that all financial markets have always been subject to manipulation and always will be subject to manipulation. It does, however, invalidate the idea that there has been a successful long-term gold-price-suppression program.

The current situation (as at the end of last week) is that gold’s true fundamentals, as indicated by the GTFM, have been bearish for the past 10 weeks. Also, the true fundamentals have spent more time in bearish territory than bullish territory since the second half of last September. Refer to the following chart comparison of the GTFM and the US$ gold price for details.

Now, considering the fundamental backdrop it seems that the gold price has held up remarkably well over the past several months, but that conclusion only emerges if your sole measuring stick is the US$. When performance relative to the other senior currency (the euro) and the world’s most important equity index (the S&P500) are taken into account it becomes clear that the gold market has been weak. Here are the relevant charts.

The fundamental backdrop is continually shifting and potentially could turn gold-bullish within the next few weeks. It just isn’t bullish right now. Also, there could be a strong rally in the US$ gold price in the face of neutral-bearish fundamentals. If so, we would be dealing with a US$ bear market as opposed to a gold bull market.

In a gold bull market the ‘value’ of an ounce of gold rises relative to the major equity indices and both senior currencies. For this to happen the true fundamentals would have to be decisively bullish most of the time.

The rising interest-rate trend in the US isn’t new and isn’t related to the Fed’s so-called “policy normalisation” program. However, it has only just started to matter.

That the rising interest-rate trend isn’t new and isn’t related to the Fed’s rate-hiking efforts is clearly illustrated by the following chart. This chart shows that the US 2-year T-Note yield began trending upward in 2011 — more than 6 years ago and more than 4 years prior to the Fed’s first rate hike.

As we go further out in duration we find later beginnings to the rising-yield trend. This is evidenced by the following three charts, the first of which shows that the 5-year yield bottomed in mid-2012, the second of which shows that the 10-year yield double-bottomed in mid-2012 and mid-2016, and the third of which shows that the 30-year yield continued to make lower lows until mid-2016. But even in the case of the 30-year yield the rising trend is now more than 18 months old.

Given that US interest rates have been rising for more than 6 years at the short end and more than 18 months at the long end, why has the trend suddenly begun to draw a lot of attention in the mainstream press?

The answer is: because rising yields on credit instruments have begun to put downward pressure on equity prices. The stock market is capable of ignoring rising interest rates for long periods, as has been demonstrated by the market action of the past few years. However, if a rising interest-rate trend persists for long enough it transforms, as far as the stock market is concerned, from an irrelevance to the most important thing.

The way that interest rates gradually turned upward over several years despite the relentless downward pressure applied by the central bank suggests that we are dealing with the end of a very long-term decline. In other words, there’s a good chance that we are now in the early stages of a 1-2 decade (or longer) rising interest-rate trend. But how could that be, when debt levels are very high and the economy-wide savings rate is very low?

Under the current monetary regime, major upward trends in interest rates are not driven by the desire to consume more in the present (the desire to save less) or by rapidly-increasing demand for borrowed money to invest in productive enterprises. That, in essence, is a big part of the problem — interest-rate trends do not reflect what they should reflect. Instead, major upward trends in interest rates are driven primarily by rising inflation expectations, or, to put it more aptly, by declining confidence in money.

Of particular relevance, under the current monetary regime it is not only possible for a large, general increase in the desire to save to be accompanied by rising interest rates, it is highly probable that when a large rise in interest rates happens it will be accompanied by a general desire to save more. It’s just that the desire for greater savings won’t manifest itself as a greater desire to hold cash. It will, instead, manifest itself as a desire to hold more of something with near-cash-like liquidity that is not subject to arbitrary devaluation by central banks and governments. Gold is the most obvious example.

[This post is a slightly-modified excerpt from a recent TSI commentary]

For a market analyst there is an irresistible temptation to seek out one or more historical parallels to the current situation. The idea is that clues about what’s going to happen in the future can be found by looking at what happened following similar price action in the past. Sometimes this method works, sometimes it doesn’t.

Assuming that the decline from the January-2018 peak is a short-term correction that will run its course before the end March (my assumption since the correction’s beginning in late-January), the recent price action probably is akin to what happened in February-March of 2007. In late-February of 2007 the SPX had been grinding its way upward in relentless fashion for many months. The VIX was near an all-time low and there was no sign in the price action that anything untoward was about to happen, even though some cracks had begun to appear in the mortgage-financing and real-estate bubbles. Then, out of the blue, there was a 5% plunge in the SPX. On the following daily chart this plunge is labeled “Warning shot 1”.

After the February-March ‘hiccup’ the SPX resumed its bull market. Both the stock market and the economy were believed to be in good shape, with the problems that had emerged in the realm of sub-prime mortgage lending generally considered to be contained to that relatively-unimportant part of the economy. No less of an authority than Ben Bernanke assured us that these problems were, indeed, contained.

The upward trend continued until mid-July, at which point another ‘out of the blue’ plunge began. This time the decline lasted 5 weeks and wiped 11% off the SPX. On the following daily chart it is labeled “Warning shot 2”.

The July-August decline was taken more seriously by almost everyone, including the Fed’s senior management. It was taken seriously enough, in fact, to prompt a reversal in the Fed’s monetary policy. The Fed entered rate-cutting mode.

During the weeks following the August-2007 low there was still widespread optimism. The overall economy was supposedly still strong, the Fed was being supportive and, as everyone knows, you should never fight the Fed.

The SPX went on to make a marginal new high in October-2007 and then commenced a bear market that over the ensuing 17 months would result in a loss of almost 60%.

The SPX was more stretched to the upside in January of 2018 than it was in February of 2007 and the more recent plunge was twice as big, but we could be dealing with Warning Shot 1. Also, this time around there may not be a second warning shot.

It is widely believed that silver leads gold during bull markets for these metals. I wonder how this belief first arose and persists to this day given that it is contrary to the historical record.

It is partially true that silver outperforms gold during precious-metals bull markets. In particular, it’s true that silver tends to achieve a greater percentage gain than gold from bull-market start to bull-market end. It’s also the case that silver tends to do better during the final year of a cyclical bull market and during the late stages of the intermediate-term rallies that happen within cyclical bull markets. However, the early stages of gold-silver bull markets are characterised by relative strength in gold.

Gold’s leadership in the early stages of bull markets is evidenced by the following long-term chart of the gold/silver ratio. The boxes labeled A, B and C on this chart indicate the first two years of the cyclical precious-metals bull markets of 1971-1974, 1976-1980 and 2001-2011, respectively. Clearly, gold handily outperformed silver during the first two years of each of the last three cyclical precious-metals bull markets that occurred within secular bull markets.

Now, in the same way that all poodles are dogs but not all dogs are poodles, the fact that gold tends to strengthen relative to silver in the early years of a precious-metals bull market doesn’t mean that substantial strength in gold relative to silver is indicative of a precious-metals bull market in its early years. For example, there was relentless strength in gold relative to silver from mid-1983 until early-1991 that took the gold/silver ratio as high as 100, but there was no precious-metals bull market during this period.

Between mid-1983 and early-1991 there was, however, a multi-year period when gold, silver, most other metals and mining stocks offered very profitable trading opportunities on the long side. I’m referring to 1985-1987. We are probably in a similar period today, with the next buying opportunity likely to arrive before the end of this quarter.