Throughout my career, I’ve primarily focused on the physical world. Tracking the price movements and trade flows of precious metals, industrial metals, coal, oil and gas has been such an everyday activity for me, it’s woven into the very fiber of my being.
But over the last few years, those commodities have periodically developed correlations with some odd bedfellows.
For instance, in a presentation in late 2018 at the New Orleans Investment Conference, I discussed how gold – traditionally correlated inversely to the US Dollar – had suddenly begun to move together.
Below is a chart of DXY versus spot gold in 2018, just to give you an idea of what I mean. Notice how on the left side, the lines move in opposite directions. Then on the right side of the chart, that trend switches and the lines move in the same direction.
Source: Bloomberg
That reversal occurred after a combined $180 billion in escalating, retaliatory tariffs were put on by both Chinese leader Xi Jinping and President Trump over a 4-month period from June to September 2018.
That period of uncertainty caused by the two countries’ burgeoning trade war was amplified by the Fed’s third interest rate hike in September of that year. By that point, investors had enough, and began to sell off risk assets at an astonishing clip, ultimately moving into safe havens like gold and the dollar.
Source: Bloomberg
I think correlations like these are important to watch, as they can provide us information about how stocks, currencies, and commodities are reacting both to each other and the world around us.
That’s why earlier this year I sat down to look at assets that were behaving like safe havens. In the process, I looked through most of the usual suspects – oil, copper, gold, US Dollars, Japanese Yen, the Euro, etc. But when I started to step outside the box, I was surprised to see a newcomer join the cast.
Tales From the Crypto
For most of bitcoin’s existence, there hasn’t been much of a price relationship to gold, as its coefficient of correlation is a fairly weak 0.5 over that period. However, during both bitcoin’s speculative collapse in 2018 and its rebound in 2019, the cryptocurrency almost served as a leading indicator for gold’s price movements, predating them by as much as 4 months.
Source: Bloomberg
In each instance of alignment, the rationale was relatively clear, as both had a corresponding geopolitical event. First, there was the bitcoin bubble pop and initiation of the US-China trade war from December 2017 to February 2018. Then, the trade war escalation and market selloff in late 2018.
If we apply that same logic to 2020, we should see a similar alignment on both the COVID-driven market selloff, and the speculative rebound.
Well, guess what…
Source: Bloomberg
Sure enough, we see both the yellow metal and bitcoin moving down in tandem as the market crashed, and moving up together as the market re-inflated. Moreover, the correlation coefficient value increased, indicating a closer relationship.
In other words, regardless of what your opinion of bitcoin may be, investors are starting to treat it as a safe haven-type store of value.
That said, the relationship has started to break down a little in recent weeks, and perhaps not in the way you might think.
Source: Bloomberg
That’s right, bitcoin has absolutely exploded since October while gold has flattened out. It’s even caused some consternation amongst analysts, with Australian bank Macquarie recently stating that gold actually peaked back in August. In that report, they say “it is increasingly likely that a Covid vaccine will be introduced in the first half of 2021 that will boost economic activity and drive 10-year T-note yields toward 2%.”
Let’s unpack that a little.
Will a vaccine be introduced? Almost certainly, yes.
Will that boost economic activity? Ultimately, yes.
But as I mentioned last week, as per the work done by Barclay’s US SMidcap Biotech Team, there’s very little chance we will be majority vaccinated until sometime toward the end of 2021.
Source: Barclays US SMid Cap Biotech Team
That means whatever stimulus a Biden Presidency can muster through the (likely) Republican-led Senate won’t be put to work until Q2 at best and won’t be fully engaged until 2022.
And while I do think that the stimulus will be infrastructure-driven, the fact is that it will cost somewhere in the trillions, and will come in addition to some sort of fiscal aid – also likely to total in the trillions.
That means the US is going to barf out into the world another massive debt issuance.
And given that we have had some difficulty finding buyers for that debt this year, that has the vast majority of financial analysts very concerned. Well, everyone except for Macquarie, apparently.
Based on my work, it seems that just like it did back in 2018 and 2019, bitcoin is a leading indicator of what is about to happen to gold prices, and possibly the market as well.
Multiple possible paths exist.
It’s possible we may see a selloff in everything next month, accompanied by a reversal in the dollar… ›just like we saw back in March. That was of course followed by a massive bull run in stocks, gold, and bitcoin.
It’s possible we may see a new, larger speculative bubble form in bitcoin similar to what happened back in 2017-18. Gold lagged this move by a few four months then, and eventually reversed following the bursting of bitcoins bubble – although in a much tighter range.
It’s possible we may see foreign countries default on USD-denominated debt – just as China state-linked conglomerate Citic Guoan Group did – forcing their governments back into the market to buy gold or USD.
But in any event, it’s clear to me that gold is going to have to rise more at some point.
As such, I’m fine adding another ¼ tranche to Proshares Ultra Gold (NYSEArca: UGL) here. And even in the event of a breakdown, I’ll be looking to pick up additional shares all the way down to support around $60 per share.
Source: Bloomberg
For what it’s worth, bitcoin traders are reportedly bracing for volatility, and some responsive selling would be expected as it approaches all-time highs. To the extent any of those sellers are safe-haven types, we should see in the next two weeks if they rotate over to gold or the USD.
All I know for sure is that it won’t be boring.
All the best,
Matt Warder