What Really Moves Gold Up Or Down? (And, It’s Not What Most Think)

Elliot Wave Technical Analyst & author @ Elliott Wave Trader
January 11, 2015

price of gold upIn answering the question posed in the title, many would simply say, “it’s all about the dollar, of course.” Others would say it is about demand in China or India.  Others would say it is the conflict seen in Russia or the Middle East.  Many were absolutely certain it would have been QE.  And, I would say that they are all wrong.

Now, let’s be honest.  We have all seen times when the dollar goes up with gold, and vice versa.  As an example, look at what has been happening since the November bottom in gold.  Metals and the dollar have risen together.  As for all the other “reasons,” well, since all of them have been “factors” which have not even hindered gold’s precipitous decline for the last 3+ years (and clearly have not caused any rally), I am not sure they are even worth discussing if we are going to be honest about it. 

So, this brings me to what I feel is the true mover of metals, and that is sentiment.  Specifically, I am speaking of the sentiment of fear more so than any other sentiment.  

Back in 1968, the bestselling book “The Money Game” by Adam Smith stated the proposition that “the strongest emotions in the marketplace are greed and fear.” In 1971, in a Harper’s Magazine article, an unnamed broker was quoted as saying “Downtown, there are two emotions: fear and greed. The rest is BS.” In 1978, New York broker William M. LeFevre was quoted in Time Magazine saying “There are only two emotions in Wall Street: fear and greed.”

Fear causes selling and drives stock prices down, whereas greed causes buying and drives prices up. However, in the precious metals market, it seems that fear is what causes a meteoric rise in prices.

And, of course, many of you long time gold investors are certain that it is the fear of inflation that is the driver of gold. But, remember, there are many reasons that people become fearful.  They can fear inflation, they can fear deflation, they can fear war, they can fear government instability, in addition to many more fears which I do not have time to enumerate. 

So, allow me to focus upon what I believe will be the next main “fear” driver for the metals, as they set up their next parabolic rise.

We have all read the multitude of theories as to whether metals do well during periods of deflation or do well during periods of inflation. Personally, I can see the arguments on both sides, as well as historical evidence to support either conclusion. But, the fact that both sides have periods to which one can point to support their position should tell us that there must be some truth to both sides.  So, if the objective evidence does not allow for a conclusive determination as to whether inflation or deflation drives metals higher, then there must be another driver of the price for metals, which is controlling during periods of both inflation and deflation.

Therefore, I believe that focusing upon the inflation/deflation argument will not assist you in gaining insight into the true mover of gold in the next great bull market of our time.  The reason I say this is that I think the next bull market in metals will be accompanied by traditional “signs” of inflation AND deflation.  In fact, I believe the next parabolic phase in metals will occur during a rising yield deflation.  And, I think this market environment will likely confound many.

Since most investors mistakenly associate rising yields with inflation, they may be caught looking the wrong way if the economic indicators are not signaling inflation, whereas yields are still rising.  But, most don’t stop to think that yields rise for many reasons, with only one of those reasons being inflation.

While yields have risen in the past due to inflationary pressures, there are other reasons as to why yields may rise.  A few years ago, we had a small taste of what a rising yield deflation feels like.  When Europe was going through its debt debacle several years ago, it caused deflationary pressures across all asset markets.  Yet, yields were rising, and, clearly, it was not being caused by inflation.  Rather, it was caused by a fear which may be coming to the shores of the United States in the not too distant future:  the fear that a government will not pay back its debt.   Yields which rise due to such a lack of trust in a government’s ability to meet its debt obligation is the most damaging and dangerous of all types of rising yields.  And, what did gold do during that period of time?  Well, as we know, it rose, and rose dramatically.

Currently, during “risk-off” periods in the market, people still “park” their money in U.S. Treasuries, which drives down the rates on the Treasuries.  For now, people still view this as a low-risk protective option.  However, once sentiment turns regarding the U.S. government’s ability to meet its debt obligation, and I assure you that it will, rates will begin to climb, but slowly at first.

But, think about it. As interest rates begin to rise over the next year or two, the current debt liability owed by the U.S. government will increase significantly due to the compounding interest upon the ever growing national debt. And, as the government has been running expanding deficits, its debt will then be increasing significantly from both ends of the equation. It will begin a snowball effect that will likely become unstoppable and unmanageable.

us government debt and gold

As rates rise, and as we see U.S. government debt burdens, both long and short term, increase significantly, we will come to a point of recognition for holders of U.S. government debt. Questions will arise as to the ability of the U.S. to meet its current obligations for interest payments on its underlying debt. This will, in turn, lead to questions about the United States’ ability to actually repay its ever increasing underlying debt burden. I believe we will see a period of time where investors holding U.S. government debt will fear that the government may not be able repay the principal, in full, on those debt obligations.

While this process is ordinarily a slow one as it begins, it does increase in speed as the market comes to this point of recognition; in other words, the point of public fear. This is what we witnessed, albeit on a much smaller scale, in Europe several years ago. However, as I said, Europe was simply the preview, if you will. When this occurs in the U.S., and I guarantee you that it eventually will, the stakes will be much greater.

But, many gold perma-bulls have been speaking of the fact that gold will go parabolic due to unsustainable U.S. government debt for decades.  Many even maintained that perspective when gold was at its highs in 2011, unable to see the impending top.  But, the difference between their perspective and my perspective is two-fold.

First, they believe the likely catalyst for a potential parabolic run in gold is imminent.  In fact, they believed it was imminent in 2011, and many have been claiming it is imminent since long before then.  I do not believe it is imminent, as I think we are still several years away from when the public’s sentiment begins to turn dramatically.  Unfortunately, many have scared you into buying metals at the highs based upon their perspective of the imminent demise of government debt and the U.S. dollar.  However, the metals have taken quite a hit, with silver losing 70% of its value from its 2011 top.  So, remember what Keynes said: “markets can remain irrational longer than you can remain solvent.”

Second, almost all believe that inflation will be the cause of the metals parabolic rise.  They believe that interest rates rise only with inflation and forget that there are many other reasons why rates rise.  However, I believe that the next interest rate rise, along with the resumption of the metals bull market, will be not be attributable to rising inflation, but will be due to the public’s eroding trust in the U.S. government’s ability to meet its debt obligations.  It is for this reason I am even able to foresee a period of time when the dollar and metals rally together.

So, as we head into a period of time over the next few years that will usher in a rising yield deflation, make sure you know the signs of this economic phenomena for which very few are prepared.  The deflationary camp will be claiming victory due to asset price destruction and, potentially, a rallying dollar, while the inflationary camp will be claiming victory due to rising interest rates and rallying gold.  But, the asset price destruction and rallying dollar will confound the inflationary camp, whereas rising interest rates and rallying gold will confound the deflationary camp.  Therefore, I intend to organize the rising-yield-deflationary camp, which will have its “campers” on the correct side of all markets, and especially the beloved yellow metal.

See Avi’s chart illustrating the wave count on the Amex Gold Bugs Index ($HUI).

Avi Gilburt is a widely followed Elliott Wave technical analyst and author of ElliottWaveTrader.net, a live Trading Room featuring his intraday market analysis (including emini S&P500, metals, oil, USD & VXX), interactive member-analyst forum, and detailed library of Elliott Wave education. You can contact Avi at: [email protected].

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