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The Gold Regime Model and Speculated Gold Strategy

Head-and-Shoulders pattern
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EDITOR NOTE: The gold regime model, which helps predict when gold will grow in value, has three key aspects. Right now, two of those three aspects are in place while the third is coming. This signals bullishness on the gold market. The three aspects of this model are: Short-term real interest rates are below 1.8% (which they are); The gold price, measured in a basket of currencies, is rising, measured by a 35-month exponential moving average (which they are); The gold price relative to the S&P 500, measured by a 35-month exponential moving average (which is on the horizon). This makes many bullish on gold, which means it might be the perfect time to invest in non-CUSIP gold and silver before the boom hits.

Until recently, ByteTree has been a crypto research and fund management company I founded some years ago. Gold will play a much bigger role in the future as we aim to offer the expertise to blend the old world with the new.

Gold Regime Model

There was a strange selloff on Friday 6 August, which carried on into Monday. It was a $100 collapse attributed to buoyant jobs data. The conspiratory theories came out in force, and for good reason. A small uptick in the US dollar didn’t justify the crash. It was a repeat of the June $150 selloff following the Fed minutes.

What’s interesting is that both falls saw the price fight back, and neither managed to break the $1,683 low seen in March. The last all-time high occurred over a year ago, on 6 August 2020, at $2,063. Back then, gold was 23% rich versus our fair value model, whereas today, it is 8% cheap. Better still, fair value back then was $1,667, whereas today, it is a whopping $1,959.

REGIME

Out of the three criteria of the gold regime model, two remain bullish and have been most of the time for two decades. The third criterium remains elusive:

  1. Short-term real interest rates are below 1.8%. TRUE

  2. The gold price, measured in a basket of currencies, is rising, measured by a 35-month exponential moving average. TRUE

  3. The gold price relative to the S&P 500, measured by a 35-month exponential moving average. FALSE - but there’s a fight coming

Gold fights back

Source: Bloomberg. Gold and the S&P 500 rebased to 100 since 2000.

Few people acknowledge that gold remains the superior asset of the 21st century, nearly twice as profitable as the S&P 500. But it was a game of two halves with gold obliterating equities in the first and the S&P smashing gold in the second. Still, gold wins overall.

I can’t help but think the next decade will belong to gold. After all, the S&P 500 trades at a lofty valuation by historic standards, while gold doesn’t. The main reason I have confidence that gold will win the 2020s is that this almighty asset bubble all around us will implode, and the crowded trades will disappoint the most. Gold is far from being crowded.

Source: Twitter.

The gold low in March seems to have legs, and at the same time, the S&P will disappoint. A 5% drawdown didn’t used to be very much in old money; now it’s becoming a rare phenomenon.

MACRO

There are many ways to describe the current cycle in asset prices. In Atlas Pulse, I normally hang my hat on real interest rates.

The 10-year US real rate is the 10-year US bond yield less the 10-year breakeven rate (expected inflation rate derives from TIPS). Gold likes falling long-term real rates and dislikes it when they rise.

The recent gold bull market (gold price $1,174) began in late 2018 when real rates peaked. Gold hit a wall during the Covid crisis in March 2020 (gold price $1,471) when real rates spiked. Crucially, gold fell 13% in the market crash when the S&P 500 fell 34%, and some other assets by much more.

As real rates collapsed, gold surged to an all-time high in August (gold price $2,063). Thereafter, long-term real rates stabilised in contrast to short-term real rates that continued to fall to levels rarely seen - bubble time.

The gold peak was followed by a surge in risky assets (no-profit tech, crypto, SPACs etc.), and gold fell back (gold price $1,683) as long-term real rates briefly rose above zero. That marked the low in both long-term real rates and the gold price. With the gold price back above $1,800, gold has done pretty well for something that has been widely written off.

The gold and real rates story

Source: Bloomberg. US real rates 2, 5, 10 and 30 year since 2016.

The Fed has more control over short-term real rates than long-term. They have driven down the former, creating an asset bubble. If the Fed were to reverse course, the impact on risky assets would be devastating. In contrast, the impact on gold would be slight (see Covid-19 crash).

Moreover, should the Fed carry on printing, which seems to be the path of least resistance, then expect long-term real rates to drift down to short-term levels, as they tend to lag. What would that mean for gold? Lift off.

The 2-year yield is 0.2%, and the breakeven is 2.5%. If the 20-year bonds could match that, then expect to see a gold price of $2,842. With inflation likely to march higher, it doesn’t have to end there. Gold is very much in a pause within a wider bull market.

VALUATION

My gold valuation methodology places the fair value at close to $1,952 while the price sits just above $1,800. What is most striking is how the fair value has kept marching ahead while the price has lagged.

Gold’s fair value keeps on rising

Gold Regime Model

Source: ByteTree TerminalMorris Gold Fair Value Model and the gold price since 2000.

It seems likely that the majority of asset allocators buy the equity story and are shy of alternatives. Career risk wins the day, and the world will return to normal. Honestly, many professional investors actually believe that.

That puts gold 8% cheap in comparison

Gold Regime Model

Source: ByteTree TerminalMorris Gold Fair Value Model: premium or discount of the gold price to fair value since 2000.

This is the greatest gold valuation methodology ever created, and it is available to the public on the ByteTree Terminal, along with ETF flows.

FLOWS AND SENTIMENT

Price and flows remained joined at the hip. The futures market, as always, follows the price chart, which is improving. The asset allocations drive the ETFs, which remain stable. It really wouldn’t take much to see investors return.

Price and fund flows

Gold Regime Model

Source: Bloomberg. Gold investor demand (ETFs and net futures) in million ounces with the gold price since 2011.

Until recently, ByteTree has been a crypto research and fund management company I founded some years ago. Gold will play a much bigger role in the future as we aim to offer the expertise to blend the old world with the new.

I’m a huge fan of crypto for many reasons, which I write about each week in ATOMIC. After all this time, I still don’t understand why the crypto space sees gold as the enemy. Surely that should be the Fed, the stockmarket, the establishment, fiat currencies and so on. You’d think.

After all, bitcoin was designed to be digital gold, which is the highest compliment. Here is an example of the anti-gold sentiment, which seems to go down so well.

Read more at ByteTree

All articles are provided as a third party analysis and do not necessarily reflect the explicit views of GSI Exchange and should not be construed as financial advice.

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