Intro
Everyone seems to think that the traditional store of value which was once gold has now been replaced by Crypto or Bitcoin. The promise of higher gold prices seen in 2020 has too easily been replaced with disdain and apathy in 2021. Sentiment in the precious metals sector is bad, but in the past couple of weeks prices have begun to perk up.
This is an article about the dueling pennants on the gold chart which standout like prominent figures over the past decade, each representing new optimism for gold bugs. Let’s take a visual look at what I’m describing, refer to the chart below:
A pennant is technical analysis jargon for a period of consolidation after a rally. There’s two such rallies and consolidations in the chart above. The first occurred in 2011-2013, the second began in 2020 and we’re still consolidating as I write this in November, 2021.
The First Pennant
In the years after the Great Financial Crisis of 2008-2009, many people assumed the Federal Reserve’s unconventional monetary policies, including quantitative easing (QE), used to rescue the financial world would lead to eventual runaway inflation and an acceleration of US Dollar debasement. The safe haven asset to protect your wealth from such a scenario was of course gold. Investors therefore piled-in, assuming the Fed would lose control due to all of the money being injected into the monetary base by QE operations. As a result, the price of gold rallied hard, reaching a high of $1,923 on Sept. 5, 2011.
You can see the growth in the monetary base for that period in the graph below:
Runaway inflation however, never actually occurred. This was because banks and financial institutions used the money injected by the Federal Reserve to shore-up their own balance sheets and regain profitability instead of lending it to borrowers. This hurt the money multiplier effect which can be seen in the velocity of money, shown below:
By March, 2013 in a policy meeting, Federal Reserve officials began to discuss the gradual process of allowing bonds to run off the Fed’s balance sheet as they matured, in an effort to return the Fed’s balance sheet to a more normal size. The Fed’s preferred measure of inflation, the personal consumption expenditure price index, excluding food and energy (Core PCE), was still less than 2% - far from runaway inflation, see below:
Gold investors figured out they were wrong, and the bullish pennant technical pattern failed on April 1, 2013. Gold prices eventually bottomed-out in late 2015 at $1,045/oz.
The Second Pennant
The most recent gold price spike was associated with the Covid19 crisis in early 2020, reaching a high of $2,089/oz. This rally corresponds with negative real interest rate policies from the Federal Reserve’s pledge to “do whatever it takes” to stabilize the financial markets. This marks the first big difference between the dueling pennants, negative interest rate policy is in effect in the current pennant:
You can see in the two charts above that negative interest rates are driving gold price higher, they are inversely correlated very well.
Let’s review another striking difference between this time vs. last time. Core PCE is running over 3.5% today, compared to below 2% during the first pennant:
So What Happens Next??
I believe the Federal Reserve is quietly conducting Yield Curve Control (YCC), putting a ceiling on interest rates and allowing inflation to run hot. If inflation continues higher and interest rates are held in place, then real interest rates will sink deeper in already negative territory. As I’ve shown above, this should cause gold to rally.
The second point is more political, but I believe it’s important. Jerome Powell is on his way out, if you don’t believe me check the betting markets here. Lael Brainard is not favored yet, but she’s trending in that direction. I’ve been saying it for a while now but I believe they’ve politically engineered a coup at the Fed. This was done in order to replace current FOMC members with doves and perhaps even modern monetary theory (MMT) believers. Brainard has already said she would use YCC in the next financial crisis.
Consensus at the Fed is currently calling for rate hikes sometime in mid-2022. If President Biden replaces chair Powell sometime before that, the Federal Reserve could easily revise the current narrative and push rate hikes further down the road. If inflation at that time continues to run at above-trend rates and interest rates remain in check, presumably capped by the glass ceiling of quiet YCC, gold will explode higher.
I expect the resulting price action in gold to be an explosion higher, breaking out of the pennant pattern to eventually reach new highs.
I’ve got a few trade ideas on how to take advantage of this thesis, but I’ll save that discussion for another day.
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