Update on Gold, Bonds, and Crypto.
Please read the Disclaimer before reading this article.
In early January 2022, I wrote an investment outlook with my views on several markets.
In this article, I want to update these views.
The following table summarizes my views from the beginning of this year, what has actually happened in the market since then, and where I stand now.
My view in early 2022
What has happened until now
My updated current view
"I think we'll see a significant correction in the broad markets this year (15% drop or higher?)."
The S&P500 declined 10% since I wrote my investment outlook, the Nasdaq declined 16%.
"With both growth and inflation slowing in 2022, how likely is it that interest rates will move substantially higher? Not so likely if you ask me.
For now, the price action is telling that interest rates will go higher, but my current guess is that fundamentals will trump the technicals."
Interest rates rose sharply. I certainly wasn't expecting an increase in interest rates this fast but as I suggested, the technicals were supportive for this possibility.
I'm more confident than ever that interest rates will decline sharply this year. Both the technicals and fundamentals are now supportive for this.
"With inflation peaking, and the correlation between commodities and inflation being very high, I think chances of another good year for commodities are rather low."
Commodities rose sharply. I wasn't expecting this at all. Would commodities have risen this sharply without the situation in Ukraine/Russia? We'll never know.
I remain bearish on commodities.
"With both growth and inflation peaking this year, I think the worst is over for gold.
I'll be looking to identify nice buy set-ups in these markets."
Gold is 8% higher.
I remain bullish on gold.
"Add to that the risk-off environment I see coming in 2022 and I can't see any reason to become bullish on these assets."
Bitcoin declined 15% (Ethereum 23%) since I wrote my investment outlook. They are now back to breakeven.
I remain bearish on this asset class.
The thing that should stand out to you from this table is the fact that my views remain the same as they were at the beginning of the year for all asset classes.
Those that have been following me know that I don't mind changing my opinion when the facts show that I'm wrong. Even though most of my predictions have come to fruition (I was wrong on commodities and partly wrong on bonds since I was not expecting this big of an increase in interest rates), you could think that the price action in bonds and commodities would change my opinion.
In this article, I'll explain why my opinion remains the same as in January.
We are currently at an inflection point with regards to where we start in the economic cycle. The current situation reminds me of Q3-Q4 2018. Back then, interest rates rose sharply and gold was in the dust. In December 2018, Goldman Sachs was calling for multiple rate hikes by the Fed in 2019 and Jeffrey Gundlach was calling for much higher interest rates.
The exact opposite happened. Interest rates declined sharply in 2019 and gold had a wonderful year. (If you wear of the opinion that rates would keep increasing in 2019, you wouldn't have become bullish on gold.)
Why did this happen? Because the economy slowed dramatically. How could we know this? Because leading indicators were predicting it.
Below is the exact chart (thanks to CrossBorder Capital) I was using at the end of 2018 to form my bullish bond and gold outlook for 2019.
The black line shows the US PMI (a measure of economic strength) and the red and yellow line are a leading indicator of the US PMI. These leading indicators were showing that the US economy would slow dramatically in 2019. So, I became bullish bonds and gold at the exact moment that "experts" were calling for higher rates.
Source: CrossBorder Capital
Today we see the same.
Below is the chart I shared in January of this year. The blue line show US PMI, the orange line is the leading indicator (please note that I haven't updated this chart since my article in January).
As you can see, economic growth will decline sharply in the coming months. There are several other models that I track and they are all showing the same thing.
If we look at history, we can see that interest rates almost always decline when the economy is slowing (as represented by declining US ISM PMI).
Add to this the fact that the ISM PMI itself is a leading indicator of inflation (the following chart by MrBlonde_macro shows this) and we know that both growth and inflation will probably start to decline very soon.
Fundamentally, this should be very bullish for bonds.
I was too early with my peak inflation call in January but I'm more convinced than ever that we are close to peaking.
Whereas in January of this year technicals were still supportive of a move higher in interest rates, we are now seeing the opposite.
I shared some charts on twitter 2 weeks ago that show this, see here.
Since then, the evidence has been building that we are close to a turning point: both the copper/gold ratio and banks/utilities ratio are not confirming this move higher in interest rates.
Add to that the following model developed by Teddy Vallee and you see why I'm bullish on bonds.
The other thing that is giving me strong conviction is the behavior in gold.
In early 2021, when the 10 year interest rates rose above 0,96%, I warned that the move higher was just beginning and that this would be bad for gold.
The following chart shows the relationship between interest rates and gold. When rates rise, gold declines (red areas), when rates decline, gold rises (green areas). (I know that interest rates can rise together with gold like in the 1970's and that it's probably better to look at real rates instead of nominal rates but I use what works in practice, not what should work in theory.)
The blue areas indicate when gold was able to hold strong despite the rise in interest rates. We saw it in 2018 and we are seeing it again right now. To me this is a clear signal that the gold market is not believing what interest rates are signaling (just like the stock market internals are not believing it for that matter).
When interest rates start to decline, this will be rocket fuel for the gold price.
If we look at the gold price in euro's, we can see that it has already moved above the highs of 2020 and already executed a successful retest as well. For those that have read some of my earlier posts, you should know that gold often moves first in other currencies and that the move in USD follows later.
If we look at the gold mining shares, we see something very interesting developing.
In early March, GDX tested resistance at the 40 USD level. Since then, it has been consolidating right below it with corrections getting smaller and smaller. This looks like a market that wants to break out and with fundamentals aligning in a big way (my expectation that interest rates will come down), that's exactly what I think the market will do.
Some final words on crypto currencies.
When gold peaked in the summer of 2020, a lot of "experts" were calling for a breakout after 1 month of correction, 3 months of correction, 6 months of correction,...
I also identified 2 or 3 possible set ups but I warned each time that I was not convinced of the fundamental picture. I leaned bullish because of technicals. Gold seemed to be breaking out but after some time, prices declined again.
We know now that the correction took around 16 months. The number of people that have called a gold bottom during these 16 months is uncountable.
The reason that technical analysis didn't work so well is because fundamentals were nog aligned.
You see how the technicals are working rather good in gold since early this year? Not surprising because the fundamentals are getting aligned.
I'm afraid that the same is happening in crypto assets. Bitcoin is rather easy to analyse from a technical standpoint when we are in a bull market. Resistance levels are rather clear, consolidations form as they should form, and breakouts don't fail.
What we are seeing now in crypto is that technical analysis seemed to stop working. Breakouts don't hold anymore as they did in the past. That's why I wrote the following at the end of March: "To summarize, I'm bullish bonds and gold and despite the breadth thrust in stock markets and bullish breakouts in high beta assets like Bitcoin, I prefer to ignore it because I'm afraid it could be a bull trap."
Since then, the S&P is 2% lower and Bitcoin is 8% lower. With the fundamental picture for Bitcoin not being bullish, you shouldn't be surprised that breakouts are not working as they should.
For those wondering what fundamentals I'm looking at, see this tweet and my prior articles.
Can I change my mind, of course I can.
As Stanley Druckenmiller explained, open-mindedness is one of the most important things to have in financial markets: "If you are going to go the rout of making concentrated bets, you also have to go the rout of being completely open minded. When the facts change, being wrong, you can’t sit down there and double down. If things don’t start to work out, you have to exit the position.”
Thank you very much for reading my article.
You can follow me on twitter: @adaptiveinvest