Don't Let Gold's Glare Blind You to Economic Realities
As the precious metal trades like a meme stock, you might think it's lost its shine. Let's see what's really going on.
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Gold is up 50% year to date. This move is despite the 10% selloff over the past week as gold reached nosebleed levels around $4,400. It has been one of the best performing assets over the past few years, beating the S&P 500 that has about 40% of its weighting in the large-cap AI-exposed names. Most have not been allocated to gold as they dismiss it as a "boring" asset, but this boring asset has outshone many traditional equities and bonds. With so much of the recent media hype, and the 10% selloff last week, has it now lost its shine?
Retail had been late investing in gold and did so using extreme leverage and derivatives. This only exacerbates the moves, both on the way up and on the way down. One can argue that the secular bull story in gold had been intact since the last few years, since the Russian invasion of Ukraine, when the world saw how the U.S. froze Russian reserves overnight due to their actions. This has shocked many global central banks that fear retribution if they were to ever be misaligned with the U.S. Hence, one trend has been intact among emerging market central banks, which is the diversification out of U.S. Treasuries into gold holdings. This is especially true for China and India.
But there are other factors as well, such as the raging U.S. national debt. Today U.S. total national debt has reached $38 trillion and taking Trump's spending plans into account, bond markets may not be able to give investors the protection they once did in the past.
In a world where rising debt is seeing no end in sight, gold and hard assets come into focus. Today the Fed has cut interest rates by another quarter percentage point, making it a total of a half-point cut this year and three-quarters of a percentage point of cuts last year. And this is despite the market being at all-time highs. The Fed clearly has a dual mandate to balance employment risks as well as inflation. The latter seems to be thrown under the bus in light of the former's weakness. With the consumer price index averaging closer to 3.2% year over year, and a labor market seeing some softness, it seems the Fed is eager to cut into a resilient economy, fueling inflation and a melt up in risk assets. The labor market has seen some seasonal weakness in August/September, which spooked the Fed, without realizing that the breakeven payroll growth is perhaps much lower now in this new economy, compared to the past.
Payroll revisions may not be as bad, and certainly cutting interest rates may not address the issue at hand, i.e. AI taking over human jobs.
The economy is like an old car, in constant need of servicing and money being thrown at it to keep it moving. With each service, it requires more and more dollars to get the same result. There is no end to fiscal spending, either, despite all the talks of cuts. Tariff revenues offset some fiscal deficits, but the spending supersedes any income generated via tariffs. It is not strange to see pullbacks of 10% or more in gold bull markets as seen during the 1970s. After periods of robust performance, it is typical to see periods of consolidation. But the investment case for gold is not over, far from it.
As the Fed has now prematurely ended quantitative tightening, looking to invest the proceeds into T-bills, it seems liquidity is once again being added to the system to keep it afloat. This only makes the case clearer for gold and hard assets as Fed's inflation target seems closer to 3%, than 2%. Given the debt to gross domestic product, perhaps that is the goal after all; inflate the debt away.
At the time of publication, Bengali had no position in any security mentioned.
