In today’s Exponential Investor

  • How far could the gold price go this time?
  • Central banks are behind the curve
  • Going cross-eyed on inflation and rates

I hope you enjoyed Part I of Nick Hubble’s brilliant research on gold earlier this week. If you missed it, it’s still available here.

Today, I’m delighted to share Part II of Nick’s excellent piece with you. Enjoy!


A turning point for gold: Part II

Nick Hubble, Gold Stock Fortunes
Originally published on 14 September 2021

In my view, you can add to this list of gold bull markets during monetary policy tightening cycles the experience of 2018 and 2019.

After the brief crisis of 2018 was averted, the Fed resumed raising interest rates and the European Central Bank announced a plan to end its QE programmes. Gold’s bull market, which was interrupted by Covid in 2020, began under these tightening monetary conditions… and led to the creation of Gold Stock Fortunes at the time.

Regardless of how you classify the last few years, I expect the same sequence of events to occur again in the future. Or just to resume post-pandemic, if you prefer.

If central bankers actually decide to tighten monetary policy – which remains a very big if – it will trigger a major gold bull market from here. Tighter monetary policy and a soaring gold price will once again take place together. It’ll be gold’s fourth turning, or the resumption of gold’s fourth turning, which began in 2015 or 2019, depending on what you focus on as the starting point.

Lundin is also ready to make his call:

So I think we’re going to see something like that this time around. We’re going to see the Fed start to make some moves towards tightening. How far along down that road they can get remains to be seen. But, just that tangible action, I think, could release whatever selling pressure remains on gold.

Before we dig into why gold outperforms during tighter monetary policy cycles, there was another nugget of you-know-what in the Wealthion interview which I’d like to mention.

A price target for gold?

Lundin also had an interesting point to make about a price target we might have for gold’s bull market:

It’s important to consider what gold has done in previous large scale secular bull markets that were based on monetary issues, which obviously this one is.

And gold, keep in mind, only became a freely trading asset in the US – the world’s most important investment market – in 1971, so there has only been three, even only two depending on how you count it, bull markets in the history of gold as an investable asset.

So, we had 1971 through basically 1974, where the gold price went up about seven or eight times in value.

We had 1976 to 1980, where the price again went up about seven or eight times in value.

We had 2000 to 2011 and gold did the same thing. It went up seven to eight times in value.

So, from the bottom that we saw in this cycle, which was about $1,040 in 2015, if gold does that kind of a thing again during this bull market, whether it takes three years, five years, or ten years, then we would at the end of it see a gold price somewhere in the $7,000 to $8,000 range.

That sounds kind of crazy right now, at these levels, but everything that’s going on in today’s world sounded crazy, sounded really insane, prior to 2008, and now it has all been normalised.

That implies gold will rise about fourfold from its current levels.

I don’t like putting targets on the gold price, especially when the monetary system is in such a mess, but that’s as good a methodology as any other.

More interesting to me is why gold’s counterintuitive action in the past actually makes perfect sense…

Why are gold bull markets triggered by tighter monetary policy?

There are several possible answers.

One is that gold booms after a crisis, as laid out in detail in past reports. As the side effects of the crisis fighting policies make their way through the economy, the gold price is a signal of the false nature of the recovery which has been engineered by governments and central bankers. Investors want to opt out of this fake boom, because it ends in a crisis, and gold is the best way to do this.

Of course, interest rate hikes tend to occur after crises too. So the two coincide.

For the current cycle, I personally prefer the explanation that central banks are often “behind the curve”. At least, they have been for the last few decades.

This phrase has a very specific and important meaning for all investors. The idea is that what seems like tighter monetary policy is not necessarily tighter monetary policy in practice. At the end of June, I first highlighted what this meant in Fortune & Freedom:

Central banks will be behind the curve again

The question in coming months and years will be a familiar one. Will central banks be “behind the curve”? This refers to the speed with which interest rates and inflation rise relative to each other.

If inflation is rising faster than interest rates, for example, then increasing interest rates is actually not necessarily tightening monetary policy. That’s an important sentence to grasp because it may be the key to unlocking the next decade of financial market action.

For monetary policy to actually be tightening, interest rates must be rising faster than inflation.

Furthermore, monetary policy tightening can mean that it is merely becoming less loose, but is still very loose.

What financial markets really care about isn’t the interest rate itself, but the real interest rate. That is, the interest rate adjusted for inflation. Consider these two examples.

The interest rate is 3% and inflation is 2%. This means the true costs of debt is actually 1%, because what you buy with the borrowed money can be rising in price by 2%.

If you borrow for a year at 3% and buy generic stuff with the proceeds, then sell that stuff in one year’s time, when the prices have gone up 2% because of inflation, and you repay your loan, it really only costs you 1% – the difference between inflation and interest rates.

But if the inflation rate rises to 5% and so central banks increase interest rates to 4%, then the true cost of borrowing falls to negative 1% because prices are rising faster than the cost of paying the debt.

It becomes a no brainer to borrow and buy, despite higher interest rates from central banks. Thus, tighter monetary policy is not necessarily tighter monetary policy in the end. It depends on what inflation is doing.

If inflation is rising faster than interest rates are, monetary policy is not actually getting tighter.

One key cause for the 2007 housing bubble was that the Fed stayed “behind the curve”, meaning that it increased rates slower than inflation. What looked like tightening monetary policy to the naked eye – increasing interest rates – actually wasn’t in real terms (meaning adjusted for inflation). Hence the housing bubble continued to inflate.

This was a great environment for gold too. The gold price surged alongside the housing bubble because, even though interest rates rose, the real rate wasn’t rising.

What we have right now is deeply negative real interest rates, as in the second example I laid out above. Inflation is running well higher than interest rates. Hence the debt bloom and surging house prices. It makes more sense to borrow and buy than save because prices are rising faster than the cost of debt.

So, will central banks raise interest rates to rein in inflation? Or, more precisely, as inflation rises, will central banks raise rates faster than inflation increases? Will they raise interest rates above inflation?

I don’t think that’s possible given the amount of debt in our economies now. Central bankers want the inflation to bail out their friends at the treasuries of the world by making all that government debt worth less.

Here’s what I do know. Now that inflation is acknowledged and central banks are twitching at the interest rate lever, we’ll need to focus on real interest rates more than ever before. Not just interest rates, but the difference between interest rates and inflation.

So, keep one eye on central banks and the other on inflation. If you go cross-eyed, expect a financial crisis as debt becomes unaffordable. If you get a lazy eye, buy gold, because central banks are behind the curve again, letting inflation run hot relative to their interest rates.

Two weeks ago, we got a taste of what rising interest rates would mean. A financial crisis like reaction in financial markets. Stocks and gold fell, while bonds rose because they’re a safe haven.

But I’m anticipating far more of the opposite – divergence between inflation and interest rates, even if the latter does go up. Central banks will be behind the curve again, triggering another bull market in gold.

This explanation is backed up by the tendency of central bankers to create investment bubbles like the housing bubble, tech bubble and the current “everything bubble”. Loose monetary policy is behind such bubbles and the fact that they occur is a signal that monetary policy really is loose, even if consumer price inflation is not roaring.

A gold bull market is another such signal. It tells you that central banks are behind the curve in tightening monetary policy. Which, in turn, reveals the inflationary pressure which drives gold bull markets even when monetary policy appears to be tightening.

But central bankers stuck behind the curve is still only one possible way to explain why gold outperforms during such periods. Another explanation is that the gold price looks to the future, not the present. In other words, the gold price is a step ahead of the economic conditions that are driving it.

Is the gold price just too farsighted for our own eyes?

Think about the gold price through the eyes of a trader. The key to making money is being one step ahead of your peers.

When the economy is recovering enough to increase the likelihood of tighter monetary policy, gold performs poorly in anticipation of that tighter monetary policy. It is one step ahead of what’s going on in the economy.

But once that shift actually happens, the trade is over and the selling pressure from the anticipated tighter monetary policy has exhausted itself. That’s why, as Lundin says above, “just that tangible action [of tightening monetary policy], I think, could release whatever selling pressure remains on gold”.

In other words, those bearish on gold placed their bets during rumours of tighter monetary policy and will sell out of those positions when confirmation hits the news. Thereafter, gold is free to rise.

In the Wealthion interview, Lundin explained these dynamics as they applied to 2015, with emphasis added:

As the Fed attempted to raise rates, and of course we know it wasn’t able to [at first], but, as it attempted to raise rates, the gold price rose. And very strongly off of what was an oversold bottom. A bottom that was created by speculators who shorted the metal in anticipation of the Fed raising rates.

Then, once the Fed actually hiked rates, having bought the rumour, those speculators sold the news, they reversed their shorts, moved on to some other trade and the pressure on the gold price was released.

In other words, the gold price is set by speculators who anticipate shifts in the economy and trade in anticipation of them. When (if) the event they are anticipating occurs, they take profits and move on.

This has the strange effect of delivering the opposite price moves in gold to what you’d expect based on the news. When traders are buying the rumour and selling the news, then they move markets in the opposite direction to what you’d expect when the news comes out.

Whatever your explanation for the counterintuitive moves in gold, they’re a well-established phenomenon.

And so I expect a new gold bull market, or the continuation of the one which began in 2015 or 2019, is about to begin as central bankers tighten.

What if central bankers don’t tighten?

Each time news of a new Covid variant pops up, and as the world digests the failure of vaccines to halt Covid restrictions in Israel, the likelihood of tighter monetary policy wanes.

But what would this mean for the gold price?

On the one hand, more loose monetary policy should be bullish for gold. But this monetary policy is usually in response to a crisis, which is bad for gold.

Remember, gold booms after a crisis as central bankers remain behind the curve with their loose monetary policy, even when it appears to be tightening.

Quite frankly, I don’t know if gold will outperform in a return to a crisis which sees even more absurd stimulus from central bankers and governments. I believe that, in such a scenario, if gold does outperform, you and I will have bigger problems on our hands than the gold price. Because it would signal that central bankers and governments have completely lost control of the financial system.

A rising gold price during a crisis signals the deflationary crash of the banking system which governments and central bankers are unable to offset, or inflation which is completely out of control.

While both of those possibilities are not off the table, especially during a pandemic, they’re not in this month’s issue. And they are scenarios during which to own physical gold itself ahead of gold stocks.

Until next time,

Nick Hubble
Editor, Gold Stock Fortunes


Many thanks to Nick for letting me share that with you.

I always find it valuable when someone takes the time to carefully evaluate the assumptions we make about investing with fresh eyes – especially when they come to new and original conclusions.

So, if you think you know what makes our favourite yellow metal tick… then think again. Because rising interest rates could do wonders for the gold price.

On a final note, in tomorrow’s Exponential Investor Sam Volkering and I will be sharing a special Christmas edition of our regular podcast, so make sure to tune in for that before settling in for what I hope will be a wonderful Christmas.

Best wishes,

Kit Winder
Co-editor, Exponential Investor