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Gold: Inflation, Fed, And Tracking The Commodity Better

September 27, 2021
Sean Streb

Hey everybody, this is a breakdown of some of the macro trends around Gold and some of the pressures it is facing from inflation and the Fed's potential rate hikes.

Overview

As of 09/26/2021, the Gold Continuous Contract is down -0.75% this week, and -3.79% for the month. Gold is currently caught in a limbo between rising inflation and rate hikes from the Federal Reserve. Inflation is positively correlated with the price of Gold, but there isn't much inflation despite all the liquidity introduced by the Fed.

The Fed

Bank of America/Merrill Lynch theorizes that Chairmen Powell will announce that QE tapering on November 3rd. The first rate hike to occur in 3Q23 and continue on a quarterly basis. The Fed currently wants inflation as it will juice the economy. If inflation pushes beyond that zone, they may decide to increase rates. Short term inflation is a large concern because of supply line disruptions in the market. If the supply chain cannot meet the demand, then the prices of goods could kick off a bout of inflation that shoots us past the 'Troublesome Zone'.

The key variable is time. If inflation rapidly increases, the fed will move up their 3Q23 plan. If this occurs, the market could react by buying Gold to hedge against a sudden inflationary episode that grew out of the Fed’s control.

Gold Stocks are Undervalued

The Gold Mining sector is trading below the 10 year Net Asset Valuation, which indicates that the miners themselves are currently undervalued, particularly the Jr. mining stocks. If the price of gold were to swing in favor of the miners, there is more pressure to revert to the mean

A New Way to Track the Price of Gold?

After a little digging, I found a Bloomberg Index fund that tracks the price of Gold with incredible accuracy. The following chart shows the top 7 major market indices with the strongest correlation to gold.

SOURCE: World Gold Council

The index with the highest correlation is the Bloomberg Barclays Global Treasury Index, which is pegged to the Global bond market, excluding US bonds and other treasuries. Both foreign bonds and Gold have an inverse relationship with the dollar, but the BBG Global Index is useful for forecasting the overall trend of gold as it offers a less volatile perspective. Due to its high correlation to gold and it’s relatively low volatility, one can chart the overall direction of gold with near 70% correlation. This correlation holds back to 2015.

The benefit of having only a .70 correlation coefficient as opposed to 100% correlation, is that it allows us to see through the "static" of Gold's volatility. The best example is near the end of the chart: GLD moves up near 6.00%, but eventually corrects down to conform with the overall downtrend signal given by the index fund.

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