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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Good morning. Cocoa prices are crashing, the Financial Times reports: “Analysts say the retreat reflects a drop-off in consumer demand as a result of the higher prices, as well as expectations of a better crop . . . speculators who had been riding the rally have more recently dumped their positions, with many now betting on falling prices.” Think that over (and read today’s letter) before you plunk another lump of cash into that gold ETF. And email us: unhedged@ft.com.
If the gold rally is about inflation and dollar debasement, why doesn’t the bond market or the dollar care?
The amazing rally in the gold price needs explaining, and one of the most popular explanations is that fiscal sanity will never return, inflation will rise and the dollar will be debased. The Wall Street Journal reports that investors are
looking for ways to shield themselves from potential fallout of US policy dysfunction, including widening budget deficits and the current government shutdown. That is pushing them into assets not denominated in dollars.
Wall Street has pointed to this move as evidence that ballooning debt and uncomfortably high inflation are disrupting the outlook for currencies underpinning the global financial system.
Ray Dalio, Bridgewater founder and believer in big debt cycles, agrees with the thesis, the FT reports:
“When you have such a supply of debt . . . it’s natural to go to an alternative storehold of wealth, which is why we’re going to harder currencies,” Dalio said in a conference in Greenwich. “Gold is the most fundamental of those.”
Ken Griffin of Citadel, another hedge fund big shot, concurs. From Bloomberg:
“We’re seeing substantial asset inflation away from the dollar as people are looking for ways to effectively de-dollarize, or de-risk their portfolios vis-à-vis US sovereign risk,” Griffin said in an interview with Bloomberg’s Francine Lacqua on Monday.
Fair enough. But the dollar’s decline ended back in April! It’s been going sideways ever since:
The idea that investors have concluded that the US will ultimately have no choice but to inflate its way out of its crushing debt load is also an awkward fit with a 30-year Treasury yield that has trended more or less sideways for two years. Long-term inflation worries just aren’t visible here:
There are several ways to resolve the contradiction between the debasement trade concept and the behaviour of the dollar and the long bond.
It may be that the “debasement” view is just plain wrong. Dario Perkins of TS Lombard says it’s just “another bullshit narrative. Emerging market central banks have clearly been buying gold, to diversify out of the dollar. That wasn’t really ‘debasement’. And now it’s become a momentum trade. The [gold] market is so illiquid, it only takes a few tinfoil hat nutters to drive the price up.” Ed Al-Hussainy of Columbia Threadneedle says the debasement idea “is just wrong — what can I tell you? If people’s views on this argument have not been changed by the data over the last six months, they are not going to change.”
Alternatively, you can argue that debasement is not just about the US, and in fact is less evident in the US than elsewhere. Gold is “is not just a rejection of the US dollar — it is a lifeboat from ALL fiat currencies”, James Athey of Marlborough Group writes. Albert Edwards of Société Générale notes to Unhedged that “the US [30-year bond] this year is an outlier in generally drifting sideways recently but on a gentle upward trend. Elsewhere the sharper upward trend is very much still intact.” He provides this chart:
You could also argue that the real story driving global investors to gold is not US inflation, but US weaponisation of the dollar. Here’s Athey:
The US’s excessive and increasingly questionable use of the US dollar as a weapon has added a massive boost to the attraction of gold. Western central banks have had the vast majority of their reserves in gold not USD for decades. The EM world has the opposite, and now is looking at a system where they need fewer US dollars to trade and they will be politically beholden to whatever crazy policies the US conjures next because they don’t want their reserves to be confiscated.
Adam Posen of the Peterson Institute agrees that gold buyers’ are not primarily motivated by inflation:
Gold prices are being driven primarily by retail investors, enemy regimes (Russia and Iran), and some speculators. It is primarily driven by investors who fundamentally distrust the US government and fiat money. Not just inflation. In fact, gold’s value (like crypto) to these people is in large part due to being uncorrelated with US macro and government (so not US inflation and the Fed).
There is also room to argue that gold is a tail hedge, not a bet that debasement of the dollar is a likely outcome. On that view, investors hold gold precisely because they also have lots of exposure to the dollar and Treasuries. This view was recently expressed in the FT:
The bond market, however, is not pricing in a loss of control over inflation. Instead, gold is being used as a “tail hedge” by investors, according to Francesca Fornasari, head of currency solutions at Insight Investment. The view was “we don’t want to have [a loss of Fed independence] as our base case, but we want to have something on”, she added.
Finally, one might argue that many investors do expect debasement to take place, but they don’t want to be short Treasuries right now because of the Trump administration’s stated determination to keep long yields low. Here is Calvin Tse of BNP Paribas:
Markets don’t want to fight the administration. The market knows that the administration has a well-publicised goal of keeping long end rates low to support economic activity and households . . . we’ve argued the Treasury can keep [long-duration Treasury] supply flat through Trump’s term (or even cut it) . . . we see the Fed buying half of net [short duration] bill supply for the next two years . . . This complements the Treasury’s plan to issue more bills and thus keeps the back end [of the yield curve] contained.
Unhedged’s view? We’re think that gold’s rally started as a fundamentally political event, driven by central banks, but has now become a momentum trade. The debasement view in its full-fat form is simply inconsistent with what we see in the Treasury and currency markets.
One good read
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