“What does a fish know about the water in which it swims all its life?”
Gold got clocked yesterday, and I was getting a lot of questions as to why. Given gold’s multi-factor and multi-duration attributes, there are a lot of ways to consider these questions, so let’s take a little risk management swim starting from the top down. Then we can move from the bottom up.
First, from global macro perspective, here are 3 major reasons why consensus loves gold:
- Protection against Fiat Fools who run Fiat Republics.
- Protection against a deflating US Dollar.
- Protection against inflation.
So let’s take these one at a time. What happens when certain Fiat Fools are forced to get fiscal religion? Austerity measures across Europe have provided a huge intermediate term tailwind for both European equities and currencies. The UK in particular is where we’ve had our bullish currency bias (long FXB) and we get how a marginal investment dollar could be allocated to the British Pound here versus US Dollars or gold.
But what about that US Dollar? What do we Gold Fishies know about the waters of down dollar equating to down gold? That’s definitely new – but that certainly doesn’t mean it can’t make sense. It’s happened before – don’t forget that DOWN DOLLAR = DOWN GOLD in the summer of 2008 – and that, my fellow fishies, wasn’t a precursor to a very friendly hootchy-kootchy kiss.
On the inflation front, our call for Q3 is that reported inflation in the US in particular rolls over sequentially versus headline CPI and PPI readings we witnessed at the cycle-highs of Q2. On the margin, that matters – if you are long gold for inflation protection in the intermediate term that is…
Duration is always critical to contextualize, so let’s swim right back up to the top and consider the setup in the gold price from a top-down quantitative perspective using our multi-duration model (TRADE, TREND, and TAIL):
- TRADE (3-weeks or less) = 1217 and that line broke in late June.
- TREND (3-months or more) = 1197 and that line broke in the last few weeks.
- TAIL (3-years or less) = 1115 and that long term line of support continues to hold.
In other words, irrespective of my long term bullish view of the gold price, if all I did was run a quant shop, I’d be shorting gold on strength (it’s immediate term oversold at 1164 this morning by the way) using an 1197 stop, with an intermediate term plan to cover my short position in the 1115 range and get really long again.
To be crystal clear, I am simplifying my analysis this morning because I only have 40 minutes to write this in 1000 words or less. But that’s not something I need to apologize for – quite often when applying the fundamental principles of chaos theory to macro market moves, there is a deep simplicity to the right answer.
For now, the answer is in the math. Over the long term, the DOLLAR DOWN = UP GOLD bulls have been fed handsomely by recognizing the inverse price relationship between these two asset classes. Like anything that gets bubbly, these bullish waters have been purified by a great story – the end of the Fiat Republic. We get storytelling, but we get math too…
Using our intermediate term TREND duration, there are two new mathematical realities that have re-surfaced in the last 3 weeks (mid-2008 style):
- There is currently a POSITIVE correlation between the US Dollar and Gold of +0.84
- The r-square between gold and USD has shot back up to +0.70
By any mathematical consideration these are very high correlation and r-square levels for the Gold Fishies to consider as we all swim up and down the proverbial fish bowl of risk management that is this interconnected marketplace.
My immediate term support and resistance levels for the SP500 are now 1090 and 1121, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer