Gold Hostage To Stocks

Gold has had a wild ride since Trump’s surprise election win in early November.  This metal first plunged then surged, ultimately making little headway.  It wasn’t until mid-April that gold regained its pre-election levels.  This overall lackluster gold action was confounding given all the mounting uncertainties.  But it once again highlights that gold investment demand is often hostage to the US stock markets’ fortunes.

Before the election, gold surged every time Trump appeared to advance in the polls.  Trump had a well-earned reputation as a loose cannon, implying far greater unpredictability.  Increasing prospects of a Trump victory drove gold to $1305 the Friday before the election.  But that weekend the FBI cleared Clinton again on her classified-e-mail front.  So gold sold off sharply on rising odds Clinton would indeed win.

On Election Day gold closed near $1276, a price that essentially wasn’t seen again until just a couple weeks ago.  As the early voting results came in that evening, Trump took a surprise lead in Florida which started to grow.  As the biggest battleground state with 29 electoral votes, Florida was an absolute must-win for Trump.  Gold futures soared in real-time to $1337 that evening, 4.8% over that day’s close hours earlier!

For months before that vote, all indications were gold would surge on a Trump victory.  Gold investment demand grows on uncertainty, and Trump is unpredictability personified.  Gold’s election-evening gains didn’t seem unreasonable, merely matching the 4.8% surge seen the day after the UK’s Brexit vote in late June that also surprised.  But a couple days after Trump’s victory, gold spiraled into a 5-week-long plunge.

How could gold’s price action pivot so radically across that election as uncertainties indeed soared?  It was an exceedingly-vexing outcome for gold investors and speculators, leaving them confounded and disheartened.  This improbable result sprung from an equally-improbable one.  Contrary to virtually all expectations pre-election, the stock markets surged in extraordinary Trumphoria after his underdog win.

Though traders often forget, gold has long been hostage to stocks.  Gold is a unique asset that tends to move counter to stock markets, making it something of an anti-stock trade.  So gold investment demand surges when stock markets weaken, as investors seek to prudently diversify their stock-heavy portfolios.  But when stock markets surge, counter-moving gold is soon forgotten so its investment demand withers.

Given gold’s global supply-and-demand fundamentals, it’s remarkable just how dominant investment demand is in driving gold’s prevailing price levels.  The definitive arbiter of gold fundamental data is the World Gold Council.  It reported that global gold investment demand accounted for only 36% of overall total demand in 2016, and just 22% in 2015.  Jewelry dwarfed that at 47% and 57% respectively those years.

Yet it’s not gold’s perennial largest demand category of jewelry that really moves its price, but its much-smaller investment one.  Investment demand drives gold prices at the margin because it is exceedingly volatile compared to gold’s other demand categories.  Between 2010 and 2016, the best jewelry-demand year was only 31% bigger than the worst one.  But this same variance in investment demand was huge at 119%!

And there’s nothing that’s driven global gold investment demand in recent years like US stock-market fortunes.  That sounds dubious, but the hard market data is crystal-clear.  Gold investment demand surges when US stock markets weaken, and slumps when they strengthen.  That’s what birthed the apparent gold anomaly after the election.  Trump won, but gold demand didn’t surge because stock markets soared.

This strong inverse relationship has played out for years, but it’s often forgotten.  The sole reason gold plunged between 2013 and 2015 was extreme Fed easing was artificially levitating the US stock markets.  That killed gold investment demand, as there is no perceived need for prudent portfolio diversification when stocks seemingly do nothing but rally indefinitely.  This same dynamic continued to play out last year.

This first chart looks at the benchmark S&P 500 stock index (SPX) and gold since early 2016.  Much of if not most of gold’s price action since then can be explained by stock-market moves.  While other gold drivers arise from time to time like Fed machinations, gold is hostage to stocks.  That makes gold one of the best investments to own when stock markets suffer in the major bears that inevitably always follow major bulls.

Back in mid-December 2015 leading into the Fed’s first rate hike in 9.5 years, gold was despised.  The SPX was less than 3% under its all-time-record peak of 2131 seen the prior May.  Complacency was off the charts, as the stock markets had fully recovered from their first correction-magnitude selloff seen in an astounding 3.6 years in August.  The Fed’s extreme easing and jawboning for more short-circuited all selling.

Thus gold slumped to an extreme 6.1-year secular low climaxing a long bear.  With those Fed-distorted stock markets magically powering higher month after month with no meaningful selloffs, investors didn’t want anything to do with gold.  It hadn’t seen a bull market since 2011, and was left for dead.  But that soon reversed after some long-suppressed SPX selling finally erupted in the wake of that initial Fed rate hike.

The SPX plunged 1.5% and 1.8% in the couple trading days after the first rate hike of the Fed’s recently-confirmed 12th rate-hike cycle since 1971.  Then a few weeks later in the first week of 2016, the SPX suffered more big down days of 1.5%, 1.3%, 2.4%, and 1.1%.  American traders were selling in sympathy with plunging Chinese stock markets rebelling against ill-fated new circuit breakers designed to retard selling.

Throughout January 2016, more sharp SPX down days of 2.5%, 2.2%, 1.2%, 1.6%, and 1.1% were seen.  While there were some big daily rebound rallies in between, investors started to realize something was changing.  The effective Fed Put they had relied upon for years to buy every dip was no longer assured with rate hikes underway.  So after years of neglect, investors finally turned to gold to shore up bleeding portfolios.

The SPX ultimately dropped 13.3% in 3.3 months leading into mid-February 2016, its worst selloff seen in 4.4 years!  That led to massive gold buying soon rekindling a new bull market.  Note above that gold’s huge rally that month coincided exactly with the SPX’s plunge.  Gold’s initial surge climaxed with a monster 4.1% daily rally the very day the SPX bottomed.  A stock-market correction unleashed a new gold bull.

But out of those lows the SPX soon reversed sharply in a V-bounce.  So gold’s upward progress all but ceased between mid-February and mid-April as the stock markets clawed higher again.  Gold could only surge to new bull highs in late April once the SPX started rolling over again.  After intensely studying this young new gold bull since its birth, I’m convinced it never would’ve happened without a major stock selloff.

As the stock markets recovered in mid-May, gold plunged on a hawkish FOMC meeting.  It wasn’t until the UK’s Brexit vote in late June with its surprise outcome clobbering the SPX that gold was finally able to surge to new bull-market highs.  But that renewed gold run ceased the very day the SPX managed to hit its first new record high in nearly 14 months in mid-July.  Gold investment demand immediately waned.

Gold suffered a healthy correction exacerbated by a rare futures mass stopping in early October.  Gold couldn’t catch a meaningful bid again until the stock markets began rolling over in October as Clinton started sliding in the polls.  Then leading into the day before the election, the FBI cleared Clinton on her classified e-mails for a second time.  The SPX surged sharply, driving a parallel sharp gold plunge that day.

Then contrary to expectations, the stock markets soared after Trump’s victory.  With a Republican sweep of the presidency, Senate, and House, euphoria set in over fast passage of deregulation, health-care reform, and massive tax cuts.  With the SPX blasting to dazzling new record highs, investors jettisoned gold they’d amassed before the election.  That heavy selling persisted until mid-December just after the SPX peaked.

See the strong inverse correlation here between gold and stocks?  It isn’t always mathematically precise, with gold sometimes rallying and falling with stocks instead of against them.  But from a broad-brush-stroke level, gold investment demand and hence gold prices weaken when stock markets are rallying.  Gold buying doesn’t materially resume until those stock rallies cease, which rekindles gold investment demand.

Gold’s latest major bottom in mid-December happened the day after the Fed hiked rates for the second time in 10.5 years.  Gold fell not on that universally-expected rate hike, but the FOMC officials’ more-hawkish-than-expected forecast of three rates hikes in 2017.  Despite that, gold still only started rallying again as the SPX’s raging Trumphoria surge in the election’s wake petered out.  Stock markets were the key.

Gold’s newest upleg slowed considerably in early February when the SPX surged on Trump teasing of “something … phenomenal in terms of tax”.  And as the SPX powered to a series of new record closes in the weeks after that, investors soon started dumping gold again.  Gold didn’t stabilize and bottom until the Fed’s 3rd rate hike in mid-March confirming a new cycle.  By that time the SPX’s progress had stalled again.

But investors didn’t start really bidding gold higher again until mid-April as the SPX started threatening to break below its critical 50-day moving average.  Sub-50dma levels hadn’t been seen since Election Day.  A 50dma breakdown after a strong, euphoric run often heralds more serious selling nearing.  The prospects of the first major post-election stock selloff erupting once again rekindled gold investment demand.

Just this week this inverse relationship reasserted itself after Sunday’s presidential election in France.  The results came in exactly as expected, averting the markets’ worst-case scenario of far-right and far-left candidates winning both runoff spots.  European stock markets soared, rekindling stock euphoria in the US.  So gold dropped sharply early this week despite a much-weaker US dollar driven by a big euro rally.

The sentiment of gold investors is heavily influenced by stock-market fortunes.  They only want to buy en masse when the SPX weakens.  That makes them remember diversifying their stock-heavy portfolios with gold is a wise idea.  But once the SPX rebounds, that newfound marginal gold investment demand soon wanes.  Because of this critical psychological link, gold is effectively held hostage by stock-market levels.

But this warring inverse relationship between gold and stocks is also fundamental, not just sentimental.  This next chart looks at the physical gold bullion held in trust for shareholders of the world’s largest and dominant gold ETF.  The GLD SPDR Gold Shares act as a conduit for the vast pools of stock-market capital to flow into and out of the global gold markets.  GLD is the actual mechanism for stocks’ gold influence!

GLD’s mission is to mirror the gold price, but its shares have their own unique supply-and-demand profile independent of gold’s.  So the only way to maintain GLD tracking of gold prices is to shunt any excess GLD-share supply or demand directly into gold itself.  Thus rising GLD holdings reveal stock-market capital flowing into gold bidding it higher, while falling ones show capital leaving forcing gold lower. 

As the biggest SPX selloff in 4.4 years spawned gold’s young bull market back in early 2016, stock-market capital flooded into physical gold bullion via GLD shares.  This differential GLD-share buying by scared stock investors desperately seeking diversification drove this ETF’s biggest monthly build in its holdings in 7.0 years!  That heavy GLD buying by American stock investors was gold’s whole story in Q1’16.

The World Gold Council only publishes gold’s global fundamental data quarterly, so that’s the highest-resolution read available.  In Q1’16 GLD’s holdings soared 176.9 metric tons.  According to the WGC’s latest data published in February 2017, total global gold demand only climbed 183.8t YoY in Q1’16.  Thus the heavy GLD gold buying alone accounted for a staggering 96.3% of total worldwide gold-demand growth.

That GLD buying soon stalled in mid-March as the SPX rallied sharply out of its correction low.  But as the stock markets started rolling over again, differential GLD-share buying resumed in late April.  That excess share demand forced GLD’s managers to issue new shares to keep GLD tracking gold.  All the proceeds were immediately plowed into buying gold bullion.  Excess GLD-share demand flows through to gold.

In Q2’16 GLD’s holdings climbed by another 130.8t.  That accounted for an incredible 91.4% of the total 143.1t YoY growth in total world gold demand per the WGC’s latest data!  Quite literally, without all that differential GLD-share buying from American stock investors there would be no new gold bull!  And the driving force behind their flight into counter-moving gold was weakness in the general stock markets.

With US stock markets inexplicably surging to new record highs soon after late June’s Brexit surprise, gold investment demand evaporated.  GLD’s holdings actually fell 2.1t in Q3’16.  And without differential GLD-share buying pressure, global gold demand actually fell a considerable 105.3t YoY that quarter.  American stock investors were still carrying the entire young gold bull at that point, there was no other real buying.

Note above in this chart that GLD’s holdings started climbing in Q4’16 before the election surprise and resulting extreme Trumphoria stock rally.  But once the SPX started soaring on big-tax-cuts-soon hopes, stock investors started fleeing gold.  The intense greed and complacency in the stock markets left gold relatively unattractive.  Why diversify portfolios when stocks are soaring and expected to continue to do so?

So in Q4’16, GLD’s holdings plunged 125.8t.  Once again, that was the entire story in worldwide gold demand.  The WGC reported total global gold demand dropped 128.7t YoY that quarter, so that crazy Trumphoria-fueled mass exodus from GLD was responsible for a staggering 97.7%!  You just can’t make this stuff up, these numbers are stunning.  Last year, GLD was truly the entire story behind gold’s price action!

GLD’s holdings only rebounded modestly in Q1’17, up just 10.2t.  And as of this writing, the WGC’s read on last quarter hasn’t been published yet.  But there was evidence in the initial months of this new year that Asian investors were taking the gold-buying baton from American stock investors.  Not only did gold see overnight rallies when US markets were closed, but the weak GLD build can’t explain gold’s 8.5% Q1 rally.

The key gold lesson since early 2016 is that US stock-market fortunes heavily influence if not dominate gold investment demand.  So the crazy Trumphoria stock-market surge after the election is likely the sole reason why gold fared so poorly in the initial months.  Despite the great uncertainties that Trump brings to the table, the perceived need to diversify portfolios waned dramatically as stocks soared on euphoria.

Thus as soon as these very-overvalued stock markets inevitably roll over into their long-overdue next bear market, gold investment demand should explode again.  Gold is the best investment to own during major stock bears, as surging investment demand drives it higher while stocks fall.  That’s way superior to holding traditional cash during stock bears, as gold actually grows capital while cash merely preserves it.

April’s GLD-holdings action showed gold investment demand already starting to pick up again as the latest SPX record highs of early March fade.  That trend will accelerate as stock selling starts to intensify.  Without the overwhelming distractions from excessive euphoria, greed, and complacency, investors will soon remember the great wisdom of prudently diversifying stock-heavy portfolios with counter-moving gold.

While gold being hostage to stocks has been bearish for it during the stock markets’ recent terminal bull years, the opposite will prove true in the coming stock-market bear years.  Gold is the bear-market asset of choice, climbing when everything else is falling.  GLD shares and gold itself will enjoy high demand as long as stock markets drift lower on balance.  But the gold miners’ stocks will really leverage gold’s gains.

During the last secular gold-stock bull, the leading gold-stock index amplified gold’s underlying gains by 2.8x.  Gold stocks can actually multiply wealth during stock bears when everything else is slowly getting mauled.  This young gold-stock bull’s upside targets are radically higher than current levels, creating vast opportunities to profit greatly as this Fed-distorted freakishly-artificial stock bull faces its overdue reckoning.

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The bottom line is gold is hostage to stocks.  This unique asset tends to move counter to stock markets, so gold investment demand is inversely correlated with their fortunes.  Investors ignore gold when the stock markets are high and euphoric, feeling no need to diversify their stock-heavy portfolios.  But once stocks inevitably start retreating, investors soon remember gold’s value and flock back to deploy capital in it.

That’s why gold suffered such heavy selling in the wake of Trump’s surprise victory.  The stock markets soared on the resulting Trumphoria, killing gold demand.  But as this extreme rally driven by unfounded hopes unwinds, so too will the gold-investment trends.  GLD will again see heavy differential buying as investors rush to re-diversify, catapulting gold and its miners’ stocks to new bull-market highs in coming months.

Adam Hamilton, CPA

April 28, 2017

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