Gold is rallying to new highs but it's not because of the usual suspects. Here's why.

  • By Randall W. Forsyth,
  • Barron's
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“Round up the usual suspects” was the classic line from the film Casablanca. When it comes to solving the riddle of gold’s rise to a seven-and-a-half-year peak, most of the usual suspects are nowhere to be found.

That’s a mystery as gold jumped $11.90 to $1756.70 an ounce for the April Comex contract Tuesday, the highest since Oct. 12, 2012. That’s also less than 7% shy of the record of $1888.70 reached on Aug. 12, 2011.

Let’s go down the list of usual suspects for gold’s bull move:

A play on rising commodities and inflation fears? Commodity prices are in a slump, led by oil, while consumer prices have been falling, in large part because of plunging energy costs.

A weak dollar? The greenback has been strong and the yellow metal is hitting records in other currencies such as the euro and the Japanese yen as well.

A hedge against risk assets such as the stock market? Gold fell sharply in March, in tandem with the equity and corporate credit markets, and has bounced back along with those sectors.

There is one other suspect lurking in the wings, the Federal Reserve.

Gold’s surge of almost 19% in a little less than a month follows the announcement by the U.S. central bank of a stunning array of various facilities to support the financial system and to complement the massive fiscal package totaling over $2 trillion to bolster the U.S. economy as it copes with the devastation wrought by the cornonavirus pandemic.

Looking at the usual suspects, gold has diverged dramatically from the rest of the commodity complex. According to Jim Paulsen, chief investment officer of Leuthold Group, writes that gold is trading at its biggest premium versus the S&P GSCI U.S. Commodity Index in over 50 years. But the S&P GSCI is heavily weighted toward energy prices, and despite the efforts of so-called OPEC+ to prop up crude oil plunged 10% Tuesday and nearly 20% over the past three sessions, to just over $20 a barrel for the U.S. benchmark crude.

For some reason, the precious metal is lumped with other tradeable goods even though it shares few of their characteristics. Every other commodity is produced to be consumed fully to be eaten or used to fuel autos or warm houses or go into manufactured goods.

Gold’s utility, as naysayers point out, is virtually nil other than as ornamentation or as coins or bars. But gold ought to be viewed as a currency, to be used as a medium of exchange or store of value. Unlike paper currencies, gold is an asset without an associated liability. Those greenbacks in your pocket are liabilities of the Fed, which holds mainly Treasury securities on the other side of its balance sheet (and now a lot of other paper, including corporate and municipal securities.)

The yellow metal is not only rising in dollar terms but also hitting record measured in euros, British pounds or Japanese yen. Alternatively, it may be said these currencies fell to record lows in terms of gold.

Gold also is seen as a hedge against risk of various sorts, and so it has been typically in tremulous times. Jeff de Graaf, head of Renaissance Macro, points out in a chart that bullion prices typically have moved up when the University of Michigan’s consumer confidence index has flagged. Confidence took a record tumble this month as claims for unemployment insurance soared by nearly 17 million in the most recent three weeks, with many more likely yet to be recorded.

But it is the coronavirus’s impact on gold has been mainly through the Fed’s action to support the credit markets and the economy. As writes Stephanie Pomboy in her most recent MacroMavens client note, the so-called barbarous relic is up only about $200 since the Fed started its frantic stimulus efforts in mid-March because its actions are seen as temporary and limited.

But she sees the Fed having to take much more permanent action to support corporate credit than generally anticipated. The central bank’s balance sheet already has shot up nearly 50% since Jan. 1, to over $6 trillion as of April 8, which she wryly suggests won’t be any more temporary the QE after the Great Financial Crisis. And that quintupling of the Fed’s balance sheet was accompanied by gold’s surge of over 50%.

None of which has gone unnoticed by investors who have flocked to funds that track gold, which attracted some $2.6 billion in the latest week, according to Bank of America Securities. The strongest performers have been exchange-traded funds that track mining stocks, such as the VanEck Vectors Gold Miners ETF (GDX) or the VanEck Vectors Junior Gold Miners ETF (GDXJ), which are up about 50% and 100%, respectively, from their March lows.

But Matt Bauer, senior research analyst at Ned Davis Research, recommends not chasing the hot gold mining ETFs, which the firm had recommended last summer to implement a bullish outlook on the precious metal.

“We urge caution this time around, with seven of the top 10 holdings for GDX and six of the top 10 for GDXJ suspending some operations (Mexico, Canada, South Africa and Peru) or withdrawing quarterly guidance. For new positions, we recommend direct exposure to the metal over the mining companies until they can clarify guidance and restart operations,” he writes in a client note. The SPDRS Gold Shares (GLD) and the iShares Gold Trust (IAU) are the two biggest that track bullion.

Even the metal itself may be due for a pause in its recent rally. But the side-effects of the economic medicine being applied by the Fed to counter the economic effects of the coronavirus will likely be higher gold prices.

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