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Gold’s True Fundamentals: Another Look

Published 03/20/2018, 01:49 AM
Updated 07/09/2023, 06:31 AM

The major long-term driver of the gold price is confidence in the official money and in the institutions (governments, central banks and private banks) that create/promote/sponsor the official money. As far as long-term investors are concerned the gold story is therefore a simple one: gold will be in a bull market when confidence in the financial establishment (money, banks and government) is in a bear market and gold will be in a bear market when confidence in the financial establishment is in a bull market.

In real time it often doesn’t seem that simple though, because on a weekly, monthly or even yearly basis a lot can happen to throw an investor off the scent. However, the risk of being thrown off the scent can be reduced by having an objective way of measuring the ebbs and flows in the confidence that drives, among other things, the performance of the gold market. That’s why I developed the Gold True Fundamentals Model (GTFM). The GTFM is determined mainly by confidence indicators such as credit spreads, the yield curve, the relative strength of the banking sector and inflation expectations, although it also takes into account the US dollar’s exchange rate and the general commodity-price trend.

An alternative to objective measurement is to rely on gut feel, but gut feel is notoriously unreliable in such matters because it is, by definition, influenced by personal biases. For example, it will be influenced by “projection bias”. This is the assumption that if you perceive things in a certain way, then most other people will perceive them in the same way.

Projection bias plays a big part in a lot of gold market analysis. The market analyst will observe central bank or government actions that from his/her perspective are blatantly counter-productive, and go on to assume, often wrongly, that most market participants will view the actions in the same way.

Another alternative is to assume that gold’s fundamentals are always bullish and therefore that any large or lengthy price decline must be the result of a grand price-suppression scheme. Given its absurdity it’s amazing how popular this line of thinking has become in the gold market. Then again, it’s a line of thinking that has been aggressively promoted over the past two decades and has a certain emotional appeal.

Due to the effects of market sentiment, the gold price occasionally will diverge from its ‘true fundamentals’ (as indicated by the GTFM) for up to a few months, but ALL substantial upward and downward trends in the gold price over the past 15 years have been consistent with the fundamental backdrop.

Does this invalidate the idea that manipulation happens in the gold market?

Of course not. Every experienced and knowledgeable trader/investor knows that all financial markets have always been subject to manipulation and always will be subject to manipulation. It does, however, invalidate the idea that there has been a successful, long-term gold-price-suppression program.

The current situation (as at the end of last week) is that gold’s true fundamentals, as indicated by the GTFM, have been bearish for the past 10 weeks. Also, the true fundamentals have spent more time in bearish territory than bullish territory since the second half of last September. Refer to the following chart comparison of the GTFM and the USD gold price for details.

GTFM Vs USD Gold Price 2013-2018

Now, considering the fundamental backdrop, it seems that the gold price has held up remarkably well over the past several months, but that conclusion only emerges if your sole measuring stick is the USD. When performance relative to the other senior currency (the euro) and the world’s most important equity index (the S&P 500) is taken into account it becomes clear that the gold market has been weak. Here are the relevant charts:

Gold:EURUSD Daily Chart

Gold:SPX Daily Chart

The fundamental backdrop is continually shifting and potentially could turn gold-bullish within the next few weeks. It just isn’t bullish right now. Also, there could be a strong rally in the USD gold price in the face of neutral-bearish fundamentals. If so, we would be dealing with a USD bear market as opposed to a gold bull market.

In a gold bull market the ‘value’ of an ounce of gold rises relative to the major equity indices and both senior currencies. For this to happen the true fundamentals would have to be decisively bullish most of the time.

Latest comments

It is interesting to use GOLD as a benchmark against all other markets to view discrepancies or to see what is trending at a given time. Gold's fundamentals I think are obviously tied to the dollar as most of the international community will have a decision between the two when looking to put their money somewhere safe and liquid. Moreover, the recent bearishness in Gold looks to be highly correlated to the weakness in the VIX and also looks to be taking cues from the Crypto trends/global resurgance of 2017. Inevitably when people are feeling good about their economic prospects they will invest more into instruments that offer a slightly higher historic return then gold and venture into riskier markets like the bitcoin and digital coins market. Gold is bought and held still in quite a few foreign countries and I see it more as a hedge for the global community when the world as a whole is not doing well. Otherwise the almighty dollar will be king as it has real time purchasing power.
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