Gold and Risk Off

The most important guide in trading and asset allocation is Price, Price & more Price.  Of course, one has to have enough sense to sniff out the BS contained in daily MSM and focus on the data points or narratives that are reasonable for asset allocation.  Surprises such as the two suffered this week can appear and one has to be nimble on the keypads to react accordingly.

If you have read my previous blog posts, you will notice that my model focuses on one simple binary strategy, Risk On or Risk Off.  The expression of this strategy is through QQQ’s or TLT’s, but readers are free to use whatever other asset they choose to express this strategy. The idea is to identify trends that capture alpha, as defined by excess return over S&P Index returns.  My model has done that with an 11.84% annualized return since November 1985, vs 8.24% for the S&P 500.

And now, the purpose of this post.

If you follow mainstream media (MSM), you will notice an uptick in the mentions regarding the bull market in Gold.  As of Friday’s close, $GOLD is up roughly 24.79% from the intraday bottom on August 16, 2018.

Of course, many have been derided as “Gold Bugs” all the way up, yet the environment has been extremely supportive of this bull market. Now, EVERYONE is looking at Gold.  The longer term charts indicate that this move is part of a longer term trend, especially when you consider the attempts by other countries to create a multi-polar world. To do so, they have to reduce their reliance on $USD as a primary currency for trade. This is unlikely in the foreseeable future, because it represents around 62% of all central bank foreign exchange reserves. Not surprisingly, China & Russia lead the world in gold reserve growth, according to data compiled by Trading Economics.

Trump´s initiatives to rebalance and reassert the US´s economic and diplomatic strength in the world is creating a sense that it is the best neighbor in a bad neighborhood. As the USD regains its leverage, foreign debt in USD is getting very expensive to repay. Add to this the suppression of rates via NIRP in EU and you have a cocktail of demand for USD´s from many sources that have the potential to drive the USD much higher. My sense is that it is happening, much to Trump’s chagrin.


While this is fantastic for Treasuries and US equities, drawing excess savings and investment is supportive of higher prices, it could create an issue in the US trade balance. Granted, Trump is in the midst of twisting arms to rearrange trade deals, so pressure is to be expected, though nobody can predict how far it will go, especially if China refuses to bow to Trump´s demands.

Now, going back to my model that compares performance of “Risk On” and “Risk Off”, it is important to remember that “Risk Off” contemplates the use of Gold when appropriate, to enhance alpha in volatile markets. The ratios in the following charts serve as indicators for my primary asset exposures. By comparing, using different denominators, I can get a sense for where the primary trend is headed.

1) $USD & $SPX are not faring as well as $GOLD versus $USB. In, fact, instead of rolling over, $GOLD is in a clear uptrend, with less volatility, supporting the idea that it is an excellent complement to $USB as a “Risk Off” asset at this stage of the cycle.

2) $GOLD has been gaining on $USB & $USD and $SPX seems to be losing its relative strength to $GOLD. This can be quite dramatic, as it was in 2007-08.

3) This graph seems to indicate $SPX has topped, $USB has not appreciated measurably and $GOLD seems to in a flattish upward trend.

What in our current environment is supporting the trend for higher $GOLD prices? Until last Wednesday, US equities seemed to have a fair amount of technical support and healthy market breadth. The Federal Reserve lowered rates by the expected 25 basis points, but the damage to confidence came in Powell’s press conference when he alluded to a “mid-cycle” adjustment, instead of paving way for an easing cycle.

Still, the equity market forgave this gaffe and recovered lost ground the very next day., only to be shot down by a Trump tweet, in which he threatened to place an additional 10% tariff on $300 billion of Chinese goods not yet impacted by tariff increases.

China has not given any hints that they are going to cede to Trump bully tactics. At some point the market grows weary of the manipulation and the typical Trump walk-back will lose its effect.

This evening, China is reported to ask state buyers to stop buying US agri-products, an important focus of Trump’s policies.

Voila, stock futures are falling off the cliff…

Precious metals are jumping…

and bonds are climbing in “Risk Off” mode.

Stay tuned.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s