Gold has been a terrible inflation hedge over the trailing 24 months. It’s gone nowhere since the summer of 2020, while every other commodities have experienced rip-roaring rallies.
The truth is, the "inflation hedge" narrative is just that – a narrative. And I believe it’s false.
But, more importantly, so does price.
I prefer to lean on John Murphy’s observation that gold has a tendency to sniff out inflation, leading to major bull runs in commodities.
And, with gold futures on the verge of breaking down to fresh two-year lows, I think it’s a good time to revisit this often misunderstood metal.
Remember, gold was the first commodity to rally in 2019 – a full year ahead of the rest of the rest of the space.
Here’s a chart of gold futures overlaid with our equal-weight commodity index, highlighting the base breakouts:
Not only did gold experience a swift rally while most commodities were fast asleep. It also hit new all-time highs before the rest of the complex even got started.
But those all-time highs are over two years old now. That was it for gold. After a solid attempt to reclaim the highs in March, the yellow metal fell right back to the lower bounds of its range.
Now, we're not rushing out to buy gold right now. That’s not the message here.
Instead, we're using its price behavior to provide insight about the potential direction of inflation and commodities as a whole.
When we overlay the 10-year breakeven inflation rate and gold, the similarities are striking. But it’s the bearish divergences that catch my eye:
Gold printed three lower highs – one in November 2021, one in April, and one late last month. All three bearish divergences led to fresh lows in the breakeven inflation rate.
I understand correlations come and go. But when I look at this chart, the strong relationship between gold and 10-year breakevens is clear.
As long as that’s the case, I will continue to view gold as a leading inflation indicator.
That’s why it’s crucial to follow gold as it nears the lower bounds of a multi-year range.
Here’s a daily chart outlining its current range:
Gold breaking down to fresh two-year lows would suggest easing inflationary pressures on the horizon.
It would also imply a deeper correction among commodities and other inflationary assets such as cyclical areas of the stock market.
That’s a lot of clout for a shiny yellow rock. But if it has a tendency to lead on the way up, I see no reason why it wouldn’t on the way down.
Of course, you could always trade It. I like gold futures short if and only if it's below 1,670, with a target at the 2020 lows of 1,450.
With countless failed breakouts and whipsaws appearing across the market recently, I’d swing a light position and play it tight.
Gold is rangebound (for now), as are most commodities and the 10-year breakeven inflation rate. But that could change at any moment.
Gold has earned a bad reputation as a directionless mess over the past two years.
Nevertheless, it now commands our full attention as it approaches a critical juncture.
Stay tuned!
COT Heatmap Highlights
Commercial hedgers hold long exposure at three-year extremes for lumber and crude oil.
Commercials carry one of their largest long position in platinum, just 600 contracts short of a new record.
And commercials added another 4,000 contracts to their net long silver position, setting a new three-year extreme.
