Gold Trapped in a Speculative Bubble

The price of gold can sometimes provide valuable insights, but at times it gives false signals, distorted by irrational market behavior. Currently, the metal has entered a speculative bubble.

The more the Federal Reserve manipulates markets by deviating from their natural rates, the more negative real rates become.

US Fiscal Imbalance

The US federal government has a large deficit.

Such a significant expenditure deficit occurs when economic growth exceeds the natural pace of growth and the pre-pandemic level. Typically, deficits are lower during periods of economic growth and higher during recessions or economic slowdowns.

However, the recent increase in debt growth is significant but not much greater than other non-crisis peaks over the last 10 years. Furthermore, it is significantly lower than the debt growth associated with a recession. A deficit of over $2 trillion sounds daunting, but since 2020 the economy has grown by 33%, or $7 trillion; since 2009, it has doubled.

When placing the current US deficit in the proper context of economic activity rates, recent growth does not differ significantly from other experiences of the past 20 years.

Thus, it is difficult to believe that US debt is the cause of the rise in gold prices.

Geopolitical Issues

The geopolitical situation, especially concerning Ukraine and Israel, is indeed tense, and it is difficult to predict the trajectory these conflicts will take. Many analysts express concerns about the deployment of nuclear weapons or the spread of war to neighboring countries, which could escalate into a broader global conflict.

Without diminishing the seriousness of these two geopolitical events or others, the US and Europe have been involved in various wars in the Middle East and Afghanistan for most of the last 20 years. Is today’s situation so much more frightening than in previous years that it will have a huge impact on the price of gold?

For example, on April 4, 2023, rumors that Iran might be planning attacks on Israel led to a more than 1% drop in the S&P 500 index and a $25 drop in the price of gold per ounce. If geopolitical issues have led to an increase in gold prices, shouldn’t heightened tension in the Middle East further increase the price of gold, rather than the opposite?

Considering these observations, it is also difficult to believe that geopolitics are responsible for the rise in gold prices.

Inflation

Some argue that higher gold prices are a warning sign that the trend of declining inflation over the past 30 years is reversing.

There is a counterargument: if gold is such a good predictor of prices, why hasn’t its price gone anywhere when the Fed and the government poured money into the economy and supply lines were disrupted? After all, this period represents the most significant inflationary situation in over 40 years:

It is also hard to believe that the rise in the prices of everyday goods is responsible for the rise in gold prices.

Federal Reserve (Fed)

Since the end of last year, the Fed has shifted from an aggressive tone to a more dovish one. Despite easy financial conditions, high and sustained inflation, and above-average growth, the Fed seems intent on cutting rates several times this year. (Many argue that a more cautious Fed will maintain its hawkish tone and possibly consider further rate hikes.)

The Fed’s monetary policy, while becoming easier, remains at its tightest level in over 15 years. Compare today’s monetary policy to that of 2013 and 2014. Back then, the US economy was also growing, but the Fed kept rates near zero and conducted QE.

However, gold languished during that period, despite the complete disregard of monetary policy. It would be somewhat of an exaggeration to claim that the Fed’s less aggressive tone has fueled a rally in gold prices.

Speculation

After reviewing some standard arguments that experts use to explain the rise in gold, there is one that may not be so popular among gold holders: gold has suddenly become a speculative asset. Accordingly, it can rise and fall—sometimes sharply—solely at the whim of traders and speculators.

Could the current rise in gold prices be less a function of the fundamental indicators raised above and more a result of speculative mania sweeping through many markets?

Consider charts that illustrate a solid statistical correlation over the past two years between Gold and Bitcoin, Nvidia, Meta, Eli Lily, and the S&P 500 index.

You’ll see how similar they are—in everything!

Conclusion:

Gold is in the speculative frenzy of a newfound bubble. But as the practice of recent years after Covid shows, bubbles not only do not burst, but are excessively resilient.

BT