Trader’s Corner — Gold as a Hedge on Chaos

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In today’s Money Weekend…gold breaks out, finally…the ‘70s without flares…buy the correction, but not yet…and more…

It looks like it’s finally time for gold to shine.

I’ve been waiting for gold to break out above US$1,880 for what seems like an eternity.

Now that it has broken above that level, I’d like to see the buying gather steam and the gold price to head to US$1,975–$2,025 over the next month or so.

Beaten-up gold stocks are finally starting to catch a bid, but the market isn’t ready to ramp them yet.

That gives you the opportunity to increase your position or to enter gold stocks if you haven’t already.

Five out of 17 stocks in the Pivot Trader portfolio are gold stocks at the moment.

I have been lowering exposure and taking profits in the big winners for months, and gold is one of the few areas of the market where I see good value.

Despite the fact markets have been rallying for the past few weeks, you shouldn’t kid yourself that we aren’t in the middle of a potentially explosive situation.

I’m expecting to see a sharp sell-off across the board in markets at some point soon, a week of selling that surprises many with its ferocity.

It can take time for a market to set up conditions for such a move, and we’re finally entering that rare zone of instability when a few bits of bad news can ignite a wildfire that spreads quickly.

Gold should provide a bit of a buffer to that sort of price action, which is why it currently has pride of place in the Pivot Trader portfolio.

The 70s without flares

I want to quote a small section of a recent Bridgewater Associates (world’s largest hedge fund) 2022 Global Outlook document to give you a sense of how unstable markets are despite the sense of calm:

Monetary Policy 3 (coordinated monetary and fiscal policy) policies have worked, transitioning economies from collapse, to liftoff, to self-sustaining growth.

The outcome has been fueled by a massive adrenaline shot of money and credit that is now producing a self-reinforcing cycle of high nominal spending and income growth that is outpacing supply, producing inflation.

The policies have also produced a layer of excess liquidity that has driven asset prices higher and left a store of liquidity in the hands of people and the financial system that will continue to have impacts as it recirculates through the system.

As a result of these policies and their effects, policy makers—and particularly the Fed—will increasingly be confronted with a set of choices that will be as challenging as any since the 1970s.

Because economies are now experiencing self-reinforcing growth, the natural workings of the economic machine will continue to sustain a high level of nominal growth that is likely to produce a level of inflation that is well in excess of policy targets.

For central banks, asymmetric policy alternatives leave an unlimited ability to tighten and a limited ability to ease on their own, which encourages delay and falling further behind, which is likely to make it increasingly difficult to balance economic growth and inflation.

Given the inertia in the system, it is unlikely that the current level of nominal spending growth and its impacts on inflation can be contained without aggressive monetary tightening in the very near term.

In contrast to this unfolding story, the markets are discounting a smooth reversion to the prior decades’ low level of inflation, without the need for aggressive policy action—that it will mostly just naturally happen on its own.

We see a coming clash between what is about to transpire and what is now being discounted. The inevitability of this clash is due to the mechanical influence of MP3 policies on nominal incomes, spending, asset prices, and inflation.

The gist is there’s a risk the Fed drags their feet in getting on top of inflation, which could lead to another leg higher in assets and then a larger crash when their hand is finally forced to create a ‘Volcker shock’ moment.

They see equities as very sensitive to rising rates but the economy itself as less sensitive because lots of printed money has been placed into the hands of the middle class who are also benefitting from rocketing house prices.

In their words:

A diminished economic sensitivity to a rise in interest rates, combined with a cautious approach to raising them, would add to the risk of falling behind the curve and of asset markets getting even further ahead of themselves, followed by a more significant tightening with an even bigger impact on asset markets at that time.

Buy the correction, but not yet

If they’re right, the scenario that plays out could see equities hit hard in the short term as rates start heading higher and the Fed attempts to lower the size of their balance sheet.

But that sell-off could be a buying opportunity as the economy continues to power ahead and the Fed starts to baulk at raising rates further for fear of causing a crash.

Inflation would remain elevated. The banks would be happily lending out their surplus deposits, raising the velocity of money and making it even harder for the Fed to get in front of the inflation that they created.

Gold should perform well in a scenario where stubbornly high inflation ensures that real rates remain negative for a long time.

With CPI inflation at 7.5% and US 10-year bond yield around 2%, there’s still a long road ahead before real rates at the long end are positive.

The next few months could be a rocky road for equities as the Fed does an about-face and starts the tricky process of raising rates.

I reckon we see a 50bp move in March and an announcement about the run-off of their balance sheet soon after.

The state of the US yield curve says the market thinks the Fed will only need to raise rates a small amount to contain inflation, and then we will return to a Goldilocks economy of high growth and low inflation.

That sounds like wishful thinking to me.

Gold is not a bad place to park some cash in case things don’t go according to the Feds plan.

Check out my Closing Bell video below, where I go into detail about the current set up in the gold price and why I think it is about to head a lot higher.


Murray Dawes Signature

Murray Dawes,
Editor, Money Weekend

PS: Watch the latest episode of my series ‘The Closing Bell’ on YouTube. Click here or the thumbnail below to view it.

Fat Tail Investment Research

About Murray Dawes

Murray Dawes is the Editor of Pivot Trader and contributing Editor at Money Morning. He was one of five, from 5,000 applicants, chosen for a graduate position with the Swiss Banking Corporation — now part of banking giant UBS. The bosses quickly cottoned on to his potential and pushed him…

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