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Today and Tomorrow

Gold has been gaining nicely in recent weeks. The biggest driver has been the US Dollar. The greenback has been sliding since almost reaching 95 in mid-November; it sits at 92.25 today.

That loss helped propel gold’s seasonal rally, which got underway as soon as the Federal Reserve raised rates on December 13th (just as predicted).

It’s a nice seasonal move, for sure! The question is how much more is yet in store and that is tough to answer given the number of factors in play. The below is nothing close to a complete list of the forces influencing gold at the moment:

  • Equities: investors love to watch the first trading days of the year as an indication of how the market will perform over the year. There is some validity to the practice – if US equities are up on the second trading day of the year (they were up today), they often end the year up – but I feel like that’s due as much to chance as cause! More generally, investors remain incredibly optimistic about US equities and complacent about risks, which suggests the bull market will remain a bull market for some time yet…until it isn’t.
  • Dollar: the dollar’s main counterpart, the Euro, has been surprisingly strong of late and gets credit for much of the dollar’s decline. How long that strength will continue is difficult to know. It’s hard to predict anything regarding Europe these days – German just posted a new record low unemployment rate but is still, after three months, unable to form a functional government and Brexit is a mess, but the Euro and the pound are performing well.
  • Bonds: through 2017 bond prices generally rose while yields fell, but that trend reversed in the fall. Now prices are falling and yields are rising. Initially that is bearish for precious metals because it means higher real rates of interest, but in the longer run it is bullish for gold because bond prices fall and yields rise when inflation rears up.
  • The Fed: this is perhaps the biggest factor this year, and for several reasons. The Fed is tightening in two ways: raising rates and letting its bond portfolio shrink as it matures. This is a dramatic change. The velocity of money will slow and the bond market will find itself with fewer buyers, especially if the European Central Bank and/or the Bank of Japan decide to follow in the Fed’s footsteps and shift to tightening. A big global financial risk this year is that one or more central banks tightens too much too fast, investing the yield curve and setting up for a recession.
  • The other big and related Federal Reserve factor this year is who – the cast of characters is set to change significantly soon. Janet Yellen will step down, replaced as Chair by Jerome Powell. Several other voting members are stepping down or rotating out and, in general, hawks are replacing doves. It’s not as stark as all that, but forced to characterize the change that’s how I would class it. This increases the likelihood of hikes and tightening…and increases the risk of inverting the yield curve, which is a reliable precursor to recession. If anything is going to slow the US bull market down, it’s an inverted yield curve.
  • Cryptocurrencies: are stealing investor attention across the board. I think very few of those currently buying bitcoin are doing so because they want to fundamentally diversify away from fiat currencies. Instead, most buyers are straight speculators, buying because the price keeps rising. Behind speculators are those operating in the shadows, who need to move money without authorities knowing. The latter is a legit application of the currency; the former is only a threat to its valuation, because speculators have no allegiance to the asset. If the game changes, they will exit, as cryptocurrencies’ crazy price gyrations have already demonstrated. All that said, if cryptos continue to rise they will continue to steal investor interest; if they crack and fall they will burn many an investor, damaging the investment market across the board for some time.

Those are the top economic forces, from where I sit. Geopolitical forces deserve a list of their own. From the uprising in Iran to North Korean nuclear threats, from the tightening of control in Saudi Arabia to continued chaos in Venezuela, from Trump to Catalonia, there are a lot of unpredictable players moving around the board right now.

I do want to end, though, by making clear that I remain bullish on metals.

It may be because of self-selecting my information, but I have come across the following chart countless times in the last few days, always used to argue that commodities – not equities – are the trade of the year.

It is a compelling graphic. Commodities are crazy cheap relative to equities. While this is already attracting attention in my world, at some point it will attract attention more broadly. Will that point require a correction in the US markets? Probably, but a correction is also quite likely. Does inflation play a role? Absolutely. Commodities perform well in inflationary environments – all prices do, but of course within that gold is a hedge against inflation, which bolsters the performance of metals as a group.

So is inflation coming? Yes. The Fed can only push and push so much for inflation before it will appear…likely more and stronger than they want. It’s like when I was drizzling chocolate on biscotti over the holidays. The melted chocolate was in a ziplock bag and I cut a tiny hole in the corner. It worked but it was frustratingly slow, so I made the hole just a touch larger…and the flood was unmanageable. There was chocolate everywhere!

Chocolate everywhere is a manageable disaster. Inflation everywhere is not. The fact that we’re seeing record real estate prices and art prices and stock prices – inflation is already here. It’s a question of when and how it manifests in everyday goods that will determine its real impact: on savings and spending.

As I’ve said before, at the moment wage inflation is the missing ingredient. Unemployment rates have been low enough for long enough that wage pressures have to be rising. This will be a key factor to watch in 2018.

But it’s not the only one.

All told, I think the easy prediction is that 2018 will be much like 2017: the US bull market will continue, gold will slowly strengthen, copper and zinc will do well, the Fed will gradually tighten, and so on. After all, a bull market is a bull market until it isn’t. From that perspective, my first guess is more of the same.

But there are a lot of forces or events that could derail the train. Paying attention to trends – like the yield curve, the dollar, inflation and real interest rates, wage inflation, metals stockpile levels, and the like – will be the only way to try to be ahead of such derailments. It’s a due your diligence kind of year.

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