Gold, Inflation, and Armageddon

Two of the primary drivers in the gold market are:

  • Armageddon, economic, and systemic fear
  • Fear of future inflation/paper currencies

Gold is typically a leader or active participant during bull markets in stocks that feature leverage and rising/positive inflation. For example, gold completed the three steps for a bullish trend change relative to stocks in 2000.

2015: Are Inflation Concerns Rising Significantly?

If you were involved in the markets during the housing bubble bull market (2002-2007), you know the market’s leadership list had a much more inflation-oriented profile. For example, rather than lagging stocks, as it has done since 2011, gold was leading stocks between 2000 and October 2007. Therefore, it is fair to ask:

“Is the recent strength in gold signaling a return to more inflation-driven leadership in the financial markets?”

Gold Has Done Some Good Things

Gold (GLD) is on our 2015 radar due to recent signs of strength and interest from market participants. However, the previous statement must also be taken in the context of the long-term downtrend in gold relative to stocks.

Gold mining stocks (GDX) have also shown some impressive strength recently. However, as shown in the chart below, GDX has made similar moves in the past within the context of a bearish relative trend (see orange arrows).

The orange arrows above seem to be leaning toward an answer to our primary question along the lines of:

Gold still has some work to do. The recent period of strength, thus far, looks similar to other periods of strength within the context of an ongoing downtrend. Said another way; so far, this looks like a countertrend rally on the chart of GDX relative to SPY. That may change soon, but we need to see more.

Stocks Will Continue To Impact Gold

Since the fears of a bear market in stocks can act as a bullish driver for safe-haven gold, a rational part of any analysis for the yellow metal should include the outlook for equities. This week’s video looks at the odds of stocks making new highs vs. the odds of stocks making new lows.

Similar Situation: Gold vs. Stocks

In order for some form of “this looks different” analysis to emerge, at some point the chart of gold relative to the S&P 500 has to move into the area near point C in the chart below. If the ratio can move closer to point C, the longer it can stay there the better for gold.

In the GLD vs. SPY chart below, notice the last major event that occurred was a lower low near point A, rather than any form of a significant new high. That may change soon, but we need to see it under our approach to the markets.

Armageddon Push vs. Inflation Push

The gold vs. stocks ratio recently broke the downward-sloping blue trend line shown below, which is a good step for the gold bulls. We can rationally call the high in the ratio that was made in late August a fear-based “Armageddon high”, given the state of the stock market at that time. We can also hypothesize the two highs that followed could be considered “fear of inflation” highs, since the markets have adjusted their expectations relative to the Fed’s easy money schedule. Notice the last two highs in the ratio were lower highs, which speaks to waning conviction to own gold relative to stocks.

In the chart above, our interest in gold would increase if the ratio can clear the orange line above point B.

Investment Implications – The Weight Of The Evidence

Can a case be made for owning gold and stocks? Yes, as part of a diversified portfolio. However, as the charts clearly show below, since August 2011 gold has significantly underperformed stocks. Under our approach, we prefer to see gold’s recent strength morph into a leadership role, which is quite a bit different than the laggard role it has played in past years. The “return to an inflation-driven market” case picks up some steam if the present day chart (right below) can morph into a look similar to the 2000-2008 chart below (left).

If gold turns in a more meaningful way, the charts will not miss it. We are open to owning gold, but need to see more.