The gold price is up while stocks are down hard. That’s very unusual in a market rout like the one we’ve been seeing over the past few weeks. What explains the divergence?
Unfortunately, there’s an entire list of narratives. Which one of them is behind the unusual price action could reveal a lot about what you should be doing with your money.
So, let’s dig in…
But first, you need to be aware of how unusual this state of affairs really is. Why does it need explaining?
There are two reasons.
The first is that gold and the stock market have been trading in lockstep for years. Especially since mid-2022, the gold ETF GLD and S&P500 have been like lovers who just bought their first home.
But something has gone terribly wrong in their relationship…
The Bank of Montreal recently pointed out to their clients that gold is at all-time highs while the S&P500 Index is down almost 10%.
The bank also pointed out the second reason why it’s so unusual: ‘That’s a very different dynamic to conventional market sell-offs when gold almost always gets sold too in order to fund liquidity constraints/calls’.
The ‘calls’ are the type of phone call which traders dread — a margin call. It’s when your investment position is going so badly that the bank gets worried you can pay up. So, they demand you put more cash in your account to prove you have the money.
Of course, traders don’t have the money. So what do they do?
Something that’s a little confusing. They sell something they don’t have. Often, that something is gold in the form of gold futures.
This initially raises cash for the trader. Which allows them to meet the margin call.
The presumption is that, in better times, the trader will cancel this gold trade, which is done by buying back the gold futures.
The broader effect is that the gold price tanks during a hard and fast market sell-off as traders rush to raise money by selling gold futures. But this is only a short-term effect that actually implies a lot of gold futures buying is actually baked in for the future.
The real point being that this is not happening today. The gold price is holding up suspiciously well, even in the short term.
So, why?
Rickards’ Asymmetric Gold Trade
One way to phrase the question is to ask why traders are not selling gold to raise cash during the crash. One possible answer to that question is that they expect the gold price to rise. This makes selling gold to raise cash a dangerous proposition. It could end up costing you, only adding to the losses that you’re trying to meet a margin call over.
This implies that traders expect the gold price to continue surging in coming months — great news for gold investors.
But it doesn’t really answer the question: why do traders expect the gold price to rise?
Jim Rickards, the strategist of Strategic Intelligence Australia, reckons it’s because of something called an ‘Asymmetric Trade’. That’s when your potential losses are capped but your gains are not. It’s almost as good as a one-way bet.
Jim reckons that any dip in the gold price triggers large-scale buying from central banks and governments around the world. They have deep pockets. Infinitely deep given they can print money.
So, the gold price can only fall so far.
Traders cannot resist this state of affairs. The odds are in gold’s favour. So they buy gold too. Which makes the gold price surge, as it has.
It’s a good narrative. And likely part of the story. But it’s only one possible explanation…
Trump tariffs could split the gold market
If Trump applies tariffs to gold imports, that will create an odd state of affairs in a gold market that is used to being global. The gold price in the US could diverge from the rest of the world because it costs suppliers tariffs to bring gold from overseas to meet US demand.
Anticipating this, the gold price is surging as traders and businesses ship vast amounts of gold to the US in anticipation of tariffs. This leads to a medium-term bump in the price of gold as the market goes haywire.
I covered this theory in detail in a video with gold market analyst Jan Nieuwenhuijs here.
Gold is the antidote to the legacy
financial system
Gold is the only major financial asset with no counterparty risk. You don’t rely on anyone else to live up to their promises to you when you own gold in your own possession. This makes it valuable when there’s doubt about the financial system holding up.
Although coverage of the stock market sell-off has focused on the Mag7 stocks in the US, it’s actually financials that have sold off worst. This in the absence of obvious reasons.
The gold price could be signalling that someone is worried about the state of the US banking system. They want out. And gold is the obvious place to go.
Central bank reaction to a coming recession
There’s growing concern that Trump’s policies will cause a recession in the US. Vast job losses and spending cuts from government, combined with a trade war, could tip GDP into contraction.
This could force the Federal Reserve to cut interest rates. Which is great news for gold.
If that’s the environment we’re going into, traders don’t want to be short gold and investors want to own gold instead of stocks. So, we’d be seeing a rotation out of stocks and into gold. The price reflects this.
Gold isn’t the only asset defying gravity
It may be unusual to see gold holding up during a market sell-off. But it’s even more unusual to see gold stocks do so.
Even when the gold price holds up during a market rout, gold stocks tend to fall by association with the stock market. That isn’t happening either.
This suggests a very intriguing change in sentiment. You see, gold stocks have been underperforming gold for years. This made sense while their costs were surging due to inflation and lockdowns. But if gold stocks are holding up now while the wider stock market tanks, that implies a radical shift.
Investors love to pile into whatever is working on the stock market. Right now, gold stocks don’t have much company. So we could be on the verge of a speculative mania in the sector.
If that begins, there is nobody better to guide you through it than Brian Chu.
Regards,
 |
Nick Hubble,
Editor, Strategic Intelligence Australia
Comments