Gold continues to trade out of its post rate hike
low (see Here) – akin to the taper low in December 2014. Our view has been
while they both represent similar market reactions, the broader reflection
that's played out in the currency markets over the past two years – presents a significant
catalyst for gold going forward. Specifically, we expect a much weaker US dollar this year.
Unlike gold's Q1 2014 rally that coincided as
the US dollar was basing and exhausted as the dollar broke out; gold has been
stepping higher since the December rate hike with what we perceive as
precarious underlying support for the US currency – that remains stretched at a
relative performance extreme. From a longer-term perspective, the inverse
correlation between gold and the US dollar index has been strengthening over
the past two years, with precious metals leading the downside move in
commodities as the US dollar rallied appreciably.
We know in past cycles – and
characteristic of markets forward discounting dynamics, the dollar strengthens
during the expectation phase of tightening and typically begins to weaken as
markets become confident that the Fed will move. Commonly understood by traders
as buy the rumor/sell the news, we've suggested its become – buy the
hype/sell the bluff with the dollar. The bluff being: the posture and
expectations shaped from comparisons to more conventional tightening cycles would ultimately
have stronger influence within the markets, than the actual structural
significance of a fractional hike. Granted, this is par for course with
the Fed and monetary policy over the past 7 years, where the behavioral reflex
inferred was arguably as or more important than the structural transmission
mechanisms themselves. Nevertheless, the dollar has walked a similar line going into the rate hike in December, regardless of whether the Fed's bark-plots eventually measure up with the reach of previous tightening cycles.
With an expectation phase for this cycle
commensurate with the extraordinary span of ZIRP, the window for participants
to build assumptions in towards the dollar has been historic. Consequently, the
move in the dollar over the past two years has been extreme; arguably, from a
relative performance perspective – as its secular blow off top was in 1985.
As equity markets stumble and expectations of
further rate hikes diminish, broad support for the dollar should modulate
lower. Increased pressure from the yen, which is attempting to break out and from euro strength – as it became a major funding currency for the markets
over the past two years, is leading the move for now. Going forward, we
expect the breadth of outperformance versus the dollar to become more
widespread as the Fed walks back their own expectations that should eventually
support a rebound in a broader basket of assets closely tied to the value of the dollar.
As a parting thought/jab, we’re reminded of an old quote that aptly sums up the hype and expectations towards the dollar over the past year.
As a parting thought/jab, we’re reminded of an old quote that aptly sums up the hype and expectations towards the dollar over the past year.
A man is like a fraction whose numerator is what he is and whose denominator is what he thinks of himself. The larger the denominator, the smaller the fraction. - Leo Tolstoy
