Don’t Fall For The Narrative!
“Every great narrative is at least two narratives, if not more- the thing that is on the surface and then the things underneath which are invisible”- Ali Smith.
As we navigate the age of information overload, we are constantly inundated with narratives through traditional media and biased algorithms of social media. Unfortunately, the dreadful experience throughout 2022 indicates that the media has become more biased than ever and has been weaponised to shield the top 1% and the men in power.
Unsurprisingly, the media houses that were created to disseminate truth reached new lows as they spewed misinformation and engaged in criminal acts when they portrayed SBF as the messiah who did no wrong.
It’s a no-brainer that even Wall Street create narratives that the traditional media disperses. The big fish on the Street tries to squeeze in all the money from the retail investors. Indeed, the nexus runs from politicians to the wealthy to the media.
The result is that year after year; income inequality attains new pinnacles as the world swims in the cruel juxtaposition of wealth and status amongst profound poverty and want.
One such narrative that the media has started running in the past month is that the central banks have begun to hoard gold, and a “sea change” is upon us in terms of the de-dollarization of the financial system.
Last year in “Blitzkrieg”, I wrote that the BRICS countries are working on an alternative currency backed by natural resources reserves. However, I also mentioned that it is a long-term process and will take decades to fructify.
Let us understand what is transpiring in the bullion market and how the price of Gold moved historically!
Let’s dig in!
FACT CHECK 1: The Big Whale!
In one of my geopolitics pieces of the last year: “Fireworks”, I covered about Russia diversifying its FX reserves and preparing for the war since 2017. I wrote:
Russia more than doubled its gold reserves from just $66 billion in June 2017 to $144 billion in Jan 2022. It reduced the dollar reserves from $191 billion to $140 billion while accumulating $77 billion in Yuan reserves. Note that overall Russian FX reserves increased from $412 billion to $630 billion.
If we look at the composition of FX reserves, the % of Gold reserves has increased from 16% to around 22%. So the elevated purchases of Gold in this period were also reflected in the CB numbers.
As we can see that, post-2018, we can see a dramatic increase in net purchases of Gold by the CBs.
Post the war and the imposition of severe sanctions on Russia, foreign businesses shut shop, and Russian imports plummeted and came to a grinding halt.
On the other hand, exports soared to record levels thanks to an enormous increase in fossil fuel prices.
As the exports surged and the imports crashed, the Current Account Surplus skyrocketed to an unprecedented 10% of the GDP.
In fact, it zoomed from $108.6 billion in Jan-Nov 2021 to $225.7 billion in Jan-Nov 2022.
Furthermore, the Western authorities froze the Russian FX reserves paralyzing the country’s ability to liquidate its FX reserves and repatriate money back home.
So, what do you do when you are flush with cash in FX earnings and can’t buy the safest bonds in the West; you start to stockpile Gold!
Yes, folks, the gargantuan Gold buying last year, the highest since 1967, can be primarily attributed to the massive Russian purchases of the shiny metal.
One should appreciate the fact that since Russia has limited options to park its FX reserves (majorly Yuan other than Gold), Russian Gold purchases will remain elevated until we get a “peace treaty”, which looks highly uncertain in the near term.
FACT CHECK 2: Inflation!
Millennials in the West have never witnessed high inflation in their lives. In his latest memo: “Sea Change”, Howard Mark calls it the third significant change in the investing landscape in his 53-year career on Wall Street (end of three decades of low-interest rates).
As a result, inflation has unintended consequences, which is challenging for new-age finance professionals to envision.
The last two years have seen inflation averaging around 4.5%+ in the US (and much higher in Europe and other parts of the world). On the contrary, Gold prices have been almost flat since inflation commenced to rise.
Thus, the nominal value of trade has expanded exponentially, and so have the FX earnings of exporter countries. Therefore, the CBs have augmented the purchases of the shiny metal.
The result: The volumes for gold seem inflated.
Now let us understand with some interesting data about the price movement historically.
One of the most significant factors influencing gold prices is the real rates on the 10-year US Treasury (Nominal — Inflation). As a thumb rule, positive real rates lead to money moving to USTs, while negative real rates fuel a rally in Gold prices and other risk assets.
Thus, the correlation between Gold prices and the Real US 10-year is negative.
As visible from the chart, ferocious moves happen in gold prices whenever there is an enormous move up or down in the 10-year real UST.
Nevertheless, this time the gold prices have not declined as anticipated, thanks to the enormous buying by Russia and the impact of inflation on nominal trade values across the world, as explained earlier.
The relative outperformance of Gold can also be tracked via the GLD/TLT ratio, which is now at a 10-year high.
The long-duration TLT (20 year+) was hammered last year (down 31% in 2022) as the Fed hiked the rates in one of the fastest tightening cycles ever, while the Gold prices remained resilient.
Clearly, Gold has been a relative outperformer compared to TLT.
The other factor that has a prominent effect on Gold prices is the greenback’s direction. The last four decades of historical data indicate that the relationship is negative.
The enormous move in Gold prices starting from 2005–2012 can be attributed to sustained lower prices of the USD, a massive increase in CBs balance sheets and safe haven buying, which led to a 4X rise in prices in seven years.
FACT CHECK 3: Manipulation!
Gold has a chequered past. Central Banks have long tried to control the prices of the shiny metal, especially before the end of the Gold Standard in 1971. But, in a mind-boggling development, post the GFC, the gold prices have been subject to manipulation by the big banks.
As you all are aware, traders at JP Morgan were involved in the manipulation of precious metals. They used “spoofing” to manipulate the prices for years.
Spoofing entails putting in fake orders in the markets to buy or sell and then withdrawing those orders before they are executed with the intention of moving the price.
JP Morgan was fined a record $920 million in 2020 for the Gold price rigging scandal.
The manipulation fears have been rife since the LIBOR scandal broke out in 2014, thus defeating the purpose of the free market in the bullion market.
Some market participants are of the view that the prices were suppressed all these years (2014–2020) due to the manipulation by the big banks.
Regardless, the shiny yellow metal remains a tried and tested inflation hedge and will find its right price in years to come as the fiat loses value due to incessant printing by the CBs.
Do watch this fantastic and insightful docuseries on Youtube to take a deep dive into the history of currencies and Gold!
Conclusion!
While the media runs propaganda that the Gold prices are moving up due to a broad-based CB buying, a deep dive shows us that the Gold prices face polarizing forces that are trying to push and pull the prices in opposite directions.
Negative Forces: Higher Dollar, Fed targeting positive real rates to control monstrous inflation
Positive Forces: Higher nominal trade/ inflation, Russia buying, Safe Haven demand
Despite significant headwinds of a higher dollar and real positive rates on the USTs, Gold outperformed most of the asset classes in 2022, thanks to enormous buying by the Russian CB and the higher nominal buying power of other CBs due to increasing inflation.
Nevertheless, the most significant trigger for prices remains the Fed pivot and will be closely watched by market participants this year. I expect the Fed to act somewhere in H2, which will start the rally in Gold prices and may lead to a fresh all-time in 2024 if not later this year.
Furthermore, as the EM currencies were battered last year, Gold prices continue to touch all-time highs in EMs every day.
Holding Gold in the PFs is a must for investors in the EMs as it may continue to outperform the domestic bonds and stocks in these countries.
If It Looks Like a Duck And Quacks Like A Duck, It Is A Duck! was originally published in DataDrivenInvestor on Medium, where people are continuing the conversation by highlighting and responding to this story.
Comments
How is it that we are unable to distill truth from lies a mile away?