This May will be a month to remember – at least for gold investors and traders. Gold soared from below $2k to $2,080, only to slide below $1,960.
This month’s performance of gold price looks like one huge shooting star candlestick. But are the implications really THAT bearish?
On a short-term basis, we see just how far gold declined this month.
At its highest point, gold was slightly above $2,080. It was trying to move above its 2022 high.
Trying.
Not succeeding.
Instead of a breakout and a move to new highs, we saw a slide. How come?
Even the most emotional rallies come to an end if they are not rooted in the current economic environment. And the key part of that environment is that the real interest rates have not only moved substantially higher in recent years. It’s that they are about to move even higher in the future.
I’ve explained this quite a few times, but I still get questions about it, so here we go once again.
Gold is moving inversely to real interest rates. There are (generally emotion-based) exceptions, but that’s the rule. It makes perfect sense, too. After all, real interest rates are what someone really (!) gets for not using their capital and lending it to someone else. The value of money decreases over time (inflation), so in order to “really” gain thanks to lending someone capital, one needs to get more than that said money loses in value. Whatever people get on top of inflation is a so-called real interest rate.
To be precise, it’s about expected inflation and not the current one, but for the sake of simplicity, let’s not go into that.
All right, so, the more people are able to get thanks to just lending out their (fiat) money, the more encouraged they will be to do it. Simple as that.
Gold has been the store of value throughout millennia, it’s a safe haven, and it has many other cool features.
But it doesn’t pay interest. In fact, you have to pay for its storage (and if you hold it in your home, well, there’s some risk associated with that as well).
So, as time passes, and the financial system doesn’t collapse (as it hasn’t in recent decades), the safe-haven aspect might not appear as important as the fact that over time it not only costs to own gold but one also misses the chance to gain interest, if one didn’t have gold, but rather a fiat currency that one would lend to someone (perhaps through buying bonds).
“But gold protects against inflation!” – one might say.
Well… Not necessarily so. Gold protects against hyperinflation, but not necessarily against regular inflation.
Remember gold’s 1980 high? It topped at $850.
According to the official inflation numbers, that amount is worth over $3,000 now.
Many expect the inflation numbers to be underreported, and if this is the case, then the real value of $850 from 1980 would be worth well over $3,000 right now – maybe even north of $4,000.
And yet, gold is trading below $2,000 right now.
Did it protect those who bought gold at the 1980 top? Not at all.
Gold declined for many years after the 1980 top, despite the fact that inflation was present then. Did it offer any protection against it? Nope.
Also, while we’re playing with the inflation calculator, let’s check how weak silver really is right now. To simplify, let’s assume that silver topped at $50 in 1980. Based on official inflation numbers (which might be too low), that’s $177 right now. And silver is trading below $24 right now – that’s just 13.6% of the 1980 high in real terms…
Interestingly enough, I do agree that the fundamental situation for silver is favorable, but I also want to emphasize that the price can decline for a long time and severely despite that. This means that stating that silver has to rally this week or month because of some supply/demand imbalances makes little sense.
Oh, and by the way, did gold protect those who have held it since the 2011 top? The $1,924 high from 2011 in real terms now is $2,495. Not really. Inflation won this battle. Speaking of battles, gold didn’t manage to move above its 2011 high in real terms despite… A freaking war in Europe!
Getting back to real interest rates, if interest rates are negative, it means two things:
- The situation is completely crazy because people are being charged for lending money to someone instead of being compensated for it.
- It makes sense to own other assets than fiat currencies because they are pretty much guaranteed to lose your capital.
Based on the first reason, the safe-haven demand for gold might increase, and based on the second point, it’s also a good idea to own gold instead of fiat currency. After all, while gold doesn’t provide interest, at least it’s not guaranteed to decline in value as fiat money would. And it has a history of being store of value, so its gleam is particularly bright in that environment.
So, again:
High real rates –> People prefer to hold fiat currencies and sell gold.
Low real rates -> People prefer to buy and hold gold.
The bigger/lower the real interest rates are, the bigger/lower the impact on gold prices will be. At least in theory, because while all the above is logical, markets don’t have to be logical.
In reality, markets are logical in the long run, but they can be emotional in the short- and medium term. This means that even though something is “obvious”, markets can choose to react to something else on a given day or week (or in a given month).
And so, while the real interest rates have been on the rise, gold hasn’t been really declining. We saw some declines, but not profound ones. The emotional stage of the market was that it was willing to ignore what’s going on, repeating the “rates will go lower soon” mantra and focusing on higher prices.
However, an emotional rally is one thing, and a move to a new all-time (nominal!) highs is something quite different. When investors were faced with this important price level, the reality kicked in.
Someone thought: “hey, the real rates are going up, maybe gold won’t really be able to move to new highs?”… And they sold. Others followed. And now we have already seen a powerful slide, even though gold was close to $2,100 earlier this month.
What does the situation in real interest rates tell us right now? That it was the preceding rally that was most likely artificial, and the current decline is the “true” direction in which the market is likely to move next.
Technically, a move back below the initial 2023 high is a very important indication. It’s a huge nope to those hoping to see gold at new highs. How is gold going to move to new all-time highs, if it just invalidated the breakout even above this year’s high?
Of course, no market moves down or up in a straight line, and there will be corrections along the way. Will we see one soon in the gold price?
The jury is still out.
The rising, medium-term support line provides support (just as its name indicates), and the same goes for the 38.2% Fibonacci retracement level. Any of them (or both) can trigger a corrective upswing. But whether it’s going to be a $3 upswing or a $50 upswing is a different matter.
The above gold chart doesn’t indicate it on its own, at least not now. Consequently, the best approach is to also analyze other markets and look for a combination of bullish factors and act (for example, by going long) only if more factors point to the same bullish outcome.
Right now, in today’s pre-market trading, we see a rather bearish indication.
Namely, the price of silver corrected much more visibly than gold did. This means that silver is outperforming gold on a short-term basis, and that’s something that tends to take place before bigger declines.
So, “now” doesn’t seem to be a good moment to enter long positions in the precious metals sector, but such an opportunity might emerge in the not-too-distant future.
As always, I’ll keep my Gold Trading Alert subscribers informed.
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Sincerely,
Przemyslaw K. Radomski, CFA
Founder, Editor-in-chief