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Takeaway: Gold is one of the few absolute return outlets in Quad #3 of our proprietary GIP framework (i.e. growth slowing as inflation accelerates).

CONCLUSIONS:

  1. We’ve been calling for investors to get longer of inflation-oriented assets in lieu of consumption-oriented assets, at the margins, as it becomes increasingly likely the Fed stops tapering (or incrementally eases) over the intermediate term.
  2. Specifically, we continue to anticipate the pace of domestic economic growth will slow, at the margins, as reported inflation accelerates, at the margins. If anything, a marginally dovish Fed only insulates our non-consensus #InflationAccelerating view.
  3. This directionally stagflationary setup is otherwise referred to as Quad #3 in our proprietary GIP framework. As the historical backtest data below highlights, Gold is among the best performing asset classes in Quad #3, along with US Treasuries, Energy stocks and Utility stocks.
  4. All told, never forget that gold is an absolute return vehicle that competes with real yields and real yields are headed south because slowing growth is dragging down nominal yields and accelerating inflation is dragging up inflation expectations (see chart below). Don’t fight the tide; fight the Fed instead.

WHERE WE’VE BEEN

Over the years, we’ve been accused of being inflationistas (2010-11), deflationistas (2012-13), perma-bulls (2009-10; 2013) and perma-bears (2010-11). Ironically enough, however, we’ve yet to be labeled as perma-anything with respect to Gold – though I’m sure being overtly bearish on Gold heading into 2013 and then turning fundamentally bullish within three weeks of the bottom probably has something to do with that:

  • THINKING WAY OUTSIDE THE BOX ON GOLD (12/14/12): “All told, we think investors should consider reducing their allocation to this asset class. At a bare minimum, it would be prudent for gold bulls to confirm whether or not our TAIL support ($1,669) holds before increasing exposure to gold here. If $1,669 breaks, there’s no true support to the prior closing lows.”
  • GOLD: IS IT TIME TO GET BACK IN ON THE LONG SIDE? (11/26/13): “Right now may be a bit early, but gold is shaping up to be a compelling long idea heading into 2014.

WHY IS GOLD (AND GOLD MINERS) RIPPING? - GOLD

Flash forward to today, Gold is up a healthy +6.1% YTD and gold miners are up an even healthier +16.9% YTD; this compares with a -2.9% decline for the S&P 500 Index and a larger -4.4% decline for the XLY (Consumer Discretionary sector SPDR).

WHY IS GOLD (AND GOLD MINERS) RIPPING? - YTD Performance

While we are certain consensus has no idea how to interpret these price signals, the aforementioned performance divergences should come as no surprise to subscribers of Hedgeye Macro research. Specifically, we’ve been calling for investors to get longer of inflation-oriented assets in lieu of consumption-oriented assets, at the margins, as it becomes increasingly likely the Fed stops tapering (or incrementally eases) over the intermediate term. Refer to our 1Q14 Macro Themes (1/9/14) and our US Economy Update Call from last Wednesday for more details.

WHERE TO FROM HERE?

We continue to anticipate the pace of domestic economic growth will slow, at the margins, as reported inflation accelerates, at the margins.

WHY IS GOLD (AND GOLD MINERS) RIPPING? - UNITED STATES   HRM

The arithmetic is actually quite simple; if the GDP deflator increases, then you need a commensurate increase in GDP to maintain the same pace of inflation-adjusted growth. Unfortunately for both buy-side and sell-side consensus, which came into 2014 as bullish as it had been in well over a year, neither the reported economic data nor bottom-up operating trends at the company level bode well for “a commensurate increase in GDP”.

WHY IS GOLD (AND GOLD MINERS) RIPPING? - UST CoT

WHY IS GOLD (AND GOLD MINERS) RIPPING? - Sell side Consensus

WHY IS GOLD (AND GOLD MINERS) RIPPING? - Eco Table 021014

WHY IS GOLD (AND GOLD MINERS) RIPPING? - ES OP Table 020714

This directionally stagflationary setup is otherwise referred to as Quad #3 in our proprietary GIP framework. As the historical backtest data below highlights, Gold is among the best performing asset classes in Quad #3, along with US Treasuries, Energy stocks and Utility stocks. The recent quantitative breakout in Brent Crude Oil bodes well for the Energy sector and the confirmed breakdown in Treasury yields bodes well for Utes (+2.9% YTD) and other yield-chasing plays (the MSCI US REIT Index is up +5.1% YTD).

WHY IS GOLD (AND GOLD MINERS) RIPPING? - GIP Backtest

WHY IS GOLD (AND GOLD MINERS) RIPPING? - Gold Backtest

WHY IS GOLD (AND GOLD MINERS) RIPPING? - Brent Crude Oil Levels

WHY IS GOLD (AND GOLD MINERS) RIPPING? - UST 10Y

While it’s early (for EM assets and commodity currencies in particular), other price signals are starting to confirm our view that the Fed is most likely to back away from tapering over the intermediate term (3-6M); in fact incremental monetary easing is not out of the question.

WHY IS GOLD (AND GOLD MINERS) RIPPING? - CRB Index

WHY IS GOLD (AND GOLD MINERS) RIPPING? - Commodities

WHY IS GOLD (AND GOLD MINERS) RIPPING? - EM

The WoW deltas in commodity currencies and EM asset plays suggest investors might want to start digging around for tactical opportunities on the long side of these asset classes. With respect to our #EmergingOutflows thesis, we’re not quite there yet on the latter, but if I can front-run my own thought process in the context of incremental confirming evidence, we’ll likely be there in another month or so.

All told, never forget that gold is an absolute return vehicle that competes with real yields and real yields are headed south because slowing growth is dragging down nominal yields and accelerating inflation is dragging up inflation expectations (see chart below). Don’t fight the tide; fight the Fed instead.

DD

Darius Dale

Associate: Macro Team

WHY IS GOLD (AND GOLD MINERS) RIPPING? - Breakevens