Gold Hedge Not Working?

A couple of quick things today:

1) Just wanted to take the chance and thank Shawn again for the many insights over the last year or so. I thoroughly enjoyed and learned from your posts. With that said, I will do my best to try and keep this blog going while juggling my current work responsibilities.

I've also personally grown through the feedback and reverberation of thoughts after my various posts and would encourage those who are interested in developing or sharpening their macro/trading analytical abilities to email the original macro man: mrmacro -at- gmail.com

2) I wanted to quickly note one point: Gold in USD terms has failed to be an optimal hedge for the most recent move in inflation expectations.


I've done a more in-depth study on gold as an inflation hedge in a past post here. I wanted to reemphasize some of those dynamics, as they seem to be at work.

Many people buy gold as a hedge for inflation expectations. That doesn't always work. The real yield has held steady and has even risen as of late - if this persists, it will be very difficult for gold to catch a bid.

Conversely, people expect inflation to be hampered if the real cost (inflation adjusted cost) of borrowing is rising. However, that is also a fallacy. Market inflation expectations are calculated via the spread between nominal bonds and inflation-linked bonds. As long as the nominal yield is rising faster than the real yield, you would, in essence, be witnessing a market expansion of inflation expectations.

However, as previously mentioned, the rising real yield would be a damper on Gold prices.



The market since the beginning of 2018 has validated this theory. There are potential scenarios for this phenomenon of flat or declining gold prices to coexist with rising market inflation expectations into the future.  For example:

- Imagine a world with persistently rising inflation (this scenario is much less controversial now than even 6 months ago)
- Central banks are now inclined to lean on the hawkish side to combat inflation (this belief is much more prevalent now than even a year ago). 
- However, global central banks are "not allowed" to raise rates fast enough because there is so much debt floating around. A combination of increases in supply (increased treasury issuances for example), and rising inflation expectations, the bond market finally has the "ah ha!" moment by selling nominals en mass. 
- The Fed cannot let real rates rise as rapidly as nominals, as it would hamper borrowing costs too much and make the existing debt incredibly difficult to service. Nevertheless, the Fed must let the real rate trend higher slowly as there is still a need to combat inflation.

The end result? Lower gold prices and higher breakeven inflation.

All-in-all, gold can be a good inflation hedge at certain times, but buyer beware - warning signs are evident.

Good luck,

DR



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39 comments

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Cbus20122
admin
April 24, 2018 at 7:16 PM ×

Good post :) .

So on today's drop (so far as of 2:10 pm), my biggest note earlier in the day was that yield-sensitive sectors like REIT's and Utilities are up big on the same day that the 10 year yield is testing 3%. Previously, the rising rates were killing these sectors, yet now they rally. I think that speaks volumes about a lot of things.

Also, as I commented last week, note the overall similarities right now with the February short-volatility blowup. Gold, oil, and bonds all are down on the same day that the market takes a hit. It's almost Deja-Vu, only that we don't have the XIV index to blow up this time.

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Nico
admin
April 24, 2018 at 8:01 PM ×

this is a rotation shit show

for the last 9 years people have been conditioned to loathe staying in cash until last January Daliosian peak herding

anyone staying in cash in 2018 will/would win big except they could not justify a management fee any longer, so here we go,

a naked short paradise on all asset classes.

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Skr
admin
April 24, 2018 at 8:09 PM ×

Detroit Red, "Many people buy gold as a hedge for inflation expectations"... I'm not so sure about that- paper gold Yes, physical No.
On an aside-the tin foil site is advocating Venezuela will be out of gold in a year's time, and Russia bought heavily in March.
I'm more interested in who is buying physical than paper.

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IPA
admin
April 24, 2018 at 10:43 PM ×

@Cbus, get out of the way on REITs. Traders got a little excited today on TNX rejection @ 3%. This is a brief reprieve before "Obliteration, Part Deux". Massive head and shoulders on all of them. Bouncing around in a bear flag here while consolidating the puke from Dec to Feb. Waiting for TNX to pop 3%.

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Cbus20122
admin
April 25, 2018 at 12:53 AM ×

I hope note, but we'll see. I only own shares in two REIT's that I feel are far removed from some of the major market risks within the sector. On the whole, part of my biggest issue with stock picking right now is I can't seem to find much of anything that I like. Despite the rate risk, I still like a few REIT's right now more than other things on the market.

With that said, I don't think many sectors looks "healthy" right now from a technical perspective.

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Cbus20122
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April 25, 2018 at 1:19 AM ×

One curious thing I'll note is that one sector that has been good to me and still looks relatively "healthy" this year is medical equipment / devices. More specifically, small cap healthcare ($PSCH) is what's really outperformed recently for me (up 12% on the year).

There are a lot of reasons for this, but I think overall it's one of the few sectors that hasn't been too affected by the major narratives that have caused problems for the markets this year.

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Skr
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April 25, 2018 at 5:53 PM ×

Lefty to win the nine ball (UK customers only)

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