A detailed analysis of the current gold pricing framework and why this framework is unsustainable. In the current framework gold is priced based on the 10-year TIPS yield. In my view, the current framework becomes more nonsensical the longer the TIPS yield stays below zero. At the time of writing the TIPS yield is –0.74%.
Note how 10 year real rates didn’t correlate at all In the 70s. In fact they never turned negative while short real rates went massively so. Supports the short rates matter case.
Also note that the 10 year real rate correlation started around 2000 - when central bank leasing dried up and the large futures short positions started to appear. Who knows - maybe they really switched from leases CB gold to synthetic gold backed by TIPS back then.
Here's something strange: why take the 10 year expected inflation rate? Clearly the purchasing power I can expect after holding a 10 year TIPS for one year depends on:
- 1 year real interest rate
- risk premium of 10 year TIPS
When deciding whether to hold gold or TIPS during a 12 month period I'd thus need to compare primarily 1 year real yield to zero. That can be a very different value than the 10 year real yield when inflation expectations are very front loaded as they are now. Which might explain the recent decoupling of real 10 year yields from gold.
What's weird is that gold doesn't appreciate at least with the money supply during times of negative yields - since that would be necessary to allow people to hold a constant share of their portfolios in gold.
Which gave me this thought: What if the astonishingly high correlation with 10 year real yields is driven by something different from portfolio allocations? I've always thought that the paper gold price suppression hypothesis doesn't hold much water since there needs to be a paper short for every paper long. And why would bullion banks hold the short side through a massive bull market?
But what if they don't just run a levered gold loan book against their reserves - i.e. if they are actually short gold in size? They'd need some way to hedge that exposure. They could sell unallocated gold and buy TIPS for example if TIPS are cheap and vice versa.
Given their market power, their connectedness and their role as market makers bullion banks could thus manage the gold price to correspond to the inverse real yield by adjusting the amount of unallocated gold sold into the market.
This would explain why gold doesn't appreciate with the money supply as increased demand could be satisfied via the alchemy of turning TIPS to paper gold. And it would explain why the correlation is with 10 year real yields, not short term real yields.
During negative yields there'd be a negative carry for the long TIPS/short gold position. But the profits which could be had by actively closing the spread would likely more than outweigh this cost.
Something like this could explain how these massive short raids (e.g. last 8 days) come about. Of course over time as the amount of "synthetic" gold grows there's increasing risk with this strategy. But that can also be hedged and the growth will be limited as the strategy itself results in gold "not working" right and people abandoning it.
An important thing to take into account, which is rarely done, is cost of production. Generally speaking, ore grades have fallen over the last decades to a degree that open pit mines now move and process a metric ton of ore to extract 1-2 grams of gold (1 to 2 parts per million). There are fewer and fewer major gold discoveries, and unless there is some major development in technology that can reduce costs, it is very possible the cost of production will go higher. Decreasing purchasing power of USD also means higher energy costs in the future (oil/diesel) which will further increase cost of production.
Great article but not jaded enough, imagine if you will that a fund was created to contribute 10% of all commissions earned on Treasury sales to purchase shorts on Gold and silver. Keeps the money rolling in. They do not even care if the shorts ever pay off as long as the market for treasuries stays strong. $5Trillion in new debt issuance commissions pays for a large short position.
It's a good point that gold should start doing better than TIPS once negative real yields become entrenched. Of course in 2020 its done significantly worse. TIPS are supported by fed purchases and gold is confronted with active short selling market participants. I find often gold leads TIPS on the way down - it's more of a derivative asset: if people have a more neutral view on it it will fall quickly as players known its reflexive properties (ie people will form their fair price estimates of gold based on where it is going) will club it down.
The dollar exchange rate is the other input to the gold price.
What Drives the Price of Gold? Part 2
The long running manipulation of the bloody Banksters favorite gig.
Selling something they do not own. See this.
“We looked into the abyss if the gold price rose further.
A further rise would have taken down one or several trading houses, which might have taken down all the rest in their wake.
Therefore at any price, at any cost, the central banks had to quell the gold price, manage it.
It was very difficult to get the gold price under control but we have now succeeded.
The US Fed was very active in getting the gold price down. So was the U.K.”
Sir Eddie George, Governor Bank of England to Nicholas J. Morrell, chief executive of Lonmin Plc, 1999
One last bit. Seasonal price of gold. See the red dotted line chart.
Surge for January and February decline due to the Chinese new year buying and then drying up.
http://www.321gold.com/charts/seasonal_gold.html
More info.....
The massive manipulation and morning smackdown by the BIS and pals, working the COMEX paper price should be mentioned.
https://thedailygold.com/the-next-fundamental-catalyst-for-gold/
Ex Post sure. But apparently not ex ante.
Check out https://www.chicagofed.org/publications/chicago-fed-letter/2021/464
Note how 10 year real rates didn’t correlate at all In the 70s. In fact they never turned negative while short real rates went massively so. Supports the short rates matter case.
Also note that the 10 year real rate correlation started around 2000 - when central bank leasing dried up and the large futures short positions started to appear. Who knows - maybe they really switched from leases CB gold to synthetic gold backed by TIPS back then.
Here's something strange: why take the 10 year expected inflation rate? Clearly the purchasing power I can expect after holding a 10 year TIPS for one year depends on:
- 1 year real interest rate
- risk premium of 10 year TIPS
When deciding whether to hold gold or TIPS during a 12 month period I'd thus need to compare primarily 1 year real yield to zero. That can be a very different value than the 10 year real yield when inflation expectations are very front loaded as they are now. Which might explain the recent decoupling of real 10 year yields from gold.
What's weird is that gold doesn't appreciate at least with the money supply during times of negative yields - since that would be necessary to allow people to hold a constant share of their portfolios in gold.
Which gave me this thought: What if the astonishingly high correlation with 10 year real yields is driven by something different from portfolio allocations? I've always thought that the paper gold price suppression hypothesis doesn't hold much water since there needs to be a paper short for every paper long. And why would bullion banks hold the short side through a massive bull market?
But what if they don't just run a levered gold loan book against their reserves - i.e. if they are actually short gold in size? They'd need some way to hedge that exposure. They could sell unallocated gold and buy TIPS for example if TIPS are cheap and vice versa.
Given their market power, their connectedness and their role as market makers bullion banks could thus manage the gold price to correspond to the inverse real yield by adjusting the amount of unallocated gold sold into the market.
This would explain why gold doesn't appreciate with the money supply as increased demand could be satisfied via the alchemy of turning TIPS to paper gold. And it would explain why the correlation is with 10 year real yields, not short term real yields.
During negative yields there'd be a negative carry for the long TIPS/short gold position. But the profits which could be had by actively closing the spread would likely more than outweigh this cost.
Something like this could explain how these massive short raids (e.g. last 8 days) come about. Of course over time as the amount of "synthetic" gold grows there's increasing risk with this strategy. But that can also be hedged and the growth will be limited as the strategy itself results in gold "not working" right and people abandoning it.
An important thing to take into account, which is rarely done, is cost of production. Generally speaking, ore grades have fallen over the last decades to a degree that open pit mines now move and process a metric ton of ore to extract 1-2 grams of gold (1 to 2 parts per million). There are fewer and fewer major gold discoveries, and unless there is some major development in technology that can reduce costs, it is very possible the cost of production will go higher. Decreasing purchasing power of USD also means higher energy costs in the future (oil/diesel) which will further increase cost of production.
Great article but not jaded enough, imagine if you will that a fund was created to contribute 10% of all commissions earned on Treasury sales to purchase shorts on Gold and silver. Keeps the money rolling in. They do not even care if the shorts ever pay off as long as the market for treasuries stays strong. $5Trillion in new debt issuance commissions pays for a large short position.
It's a good point that gold should start doing better than TIPS once negative real yields become entrenched. Of course in 2020 its done significantly worse. TIPS are supported by fed purchases and gold is confronted with active short selling market participants. I find often gold leads TIPS on the way down - it's more of a derivative asset: if people have a more neutral view on it it will fall quickly as players known its reflexive properties (ie people will form their fair price estimates of gold based on where it is going) will club it down.
The dollar exchange rate is the other input to the gold price.
More factors reviewed of interest:
https://sprott.com/insights/sprott-gold-report-waiting-for-the-pivot/#