Gold prices seem to have settled in around the $1,400 range recently. Whether or not that price is a psychological attractor for both buyers and sellers, there does seem to be some degree of market stability around that level currently. While it is impossible to say how long this illusion of stability will last, there seems to be a confluence of trends contributing to all of this.
On the gold bear side, we most often hear about how the stronger dollar is a negative factor for gold prices. That is somewhat of a non sequitur right from the start – if a rising dollar was “bad” for gold prices then how does gold trade across currency denominations in virtual lockstep with dollar quoted gold?
In the most vivid example of a “strong” dollar period, the volatile period leading into the panic of 2008, the correlation of daily price changes (r-squared) across these three denominations was 0.83. For the entire period shown above, correlation was 0.725. If a strong dollar was bad for gold in dollars, why would it also be bad for gold in euros or sterling?
That is particularly true during the height of the euro banking crisis into 2011. The weak euro should have been both positive for gold in euros and negative for gold in dollars, yet the correlation was just as strong and positive. The “strong” dollar, for whatever it is supposed to signal, has little meaning to gold. The only caveat here is whether the dollar is a sign of illiquidity, and even then the US dollar is a derivative variable to gold and acts contrary to all expectations (for this “strong” dollar argument).
It is not currency that so much drives gold as fear. There are different manifestations of fear, from inflation to deflation (to use the mainstream economic vernacular). The former has been largely dispelled by the last four years of economic failure, while the latter continues to force central banks into desperate measures. Despite all the massive currency debasement across the globe, inflation is not the primary danger.
The system, particularly the banking system, interconnected as it is, is still in a critical state of dysfunction. The very acts of central banks tell us as much, though we get so many secondary indications such as volatility and collateral shortages. Where gold is applicable here is the conventional idea of “tail risk”.
A susceptible system is one in which there are embedded expectations for violent phase shifts. The system will either be fixed, or it will have to move into something else that will feature more durable stability. Central banks in their “extraordinary” programs seek to force the financial system to accept the illusion of stability, that they have permanently fixed the ailments.
The “markets”, to some large degree, have accepted this illusion, at least temporarily. Volatility expectations and hedging activity have subsided to create a “quiet” period, particularly in those regions where volatility was especially acute (Europe). In this regard, the gold bears have an ally in their arguments. If the relatively low degrees of visible financial risk turn out to be “correct” in their expectations of the future, then gold prices would fall as demand for the ultimate “safety” declines precipitously.
In other words, gold prices are largely a bet on the efficacy of the current state of managerial central banking and central planning. Is the illusion of stability real, or just an illusion?
The very talk of taper, which is also being used in the gold bear camp, is actually evidence of the illusion. Tail risks have not disappeared, rather financial markets have been co-opted or outright “bought” by central banks. In this bizarre investment world, the small indications of riskiness are actually the opposite – by suppressing hedging and prudent risk management (as speculators jump into whatever risk markets central banks create with their debasement) these markets are actually quite risky.
In gold terms, over the longer run fear of “tail risks” will only subside when organic stability actually emerges. I still have little doubt that the smash in gold prices this year was driven by rising illiquidity on several continents, but the lack of robust rebound in gold speaks to these other factors. With Abenomics in the global driver seat against the backdrop of US recession, Chinese slowdown (maybe even industrial contraction) and durable European depression, it is hard to imagine how any illusion of stability could be anything but.
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