The market meaning of a gold breakout

Gold bulls became very excited when gold prices tested overhead resistance at the 2000–2100 level. In the past, such tests had been met with selling pressure, but technical analysts would interpret a definitive breakout at these levels as opening the door to significant upside.


Moreover, the bottom panel of the accompanying chart shows that the gold to S&P 500 ratio has been making a multi-year bottom, which argues for the start of a cycle that favours hard assets like gold and commodities over paper assets like stocks and bonds. Before you get too excited, such bottoms can take some time to develop and a hard asset bull market may not appear for several years.



In addition, the long-term bull case for commodities and hard assets is underscored by a regime of chronic underinvestment in capital expenditures in commodity extraction industries.



I am no gold bug and I have no strong opinion on the direction for gold prices. I am more interested in the cross-asset implications of this gold rally.



What’s driving gold prices?

What’s driving gold prices? Historically, gold has been inversely correlated to the USD Index. However, the relationship began to diverge in late 2014 and diverged further in 2021. If history is any guide, gold prices should be a lot weaker than it is today.



In addition, gold is positively correlated to the price of inflation-indexed bonds (TIPS) and inversely correlated to TIPS yields. A similar bearish divergence appeared in late 2022. To be sure, similar negative divergences showed up in 2006 when gold prices began to rally and the divergence didn’t close until 2013–2016.


The bond and TIPS market received a boost when Fed Governor Christopher Waller gave a dovish update to his assessment of the economy. In a previous speech on October 18, 2023 (see Something’s Got to Give), Waller highlighted a divergence in the economy and a question for Fed officials. Economic growth seems to be accelerating while inflation is slowing. Either inflation reaccelerates, which would force the Fed to adopt a tighter monetary policy, or the economic slows, which allows a more dovish path [emphasis added].

The data in the past few months has been overwhelmingly positive for both of the FOMC’s goals of maximum employment and stable prices. Economic activity and the labor market have been strong, with what looks like growth well above trend and unemployment near a 50-year low. Meanwhile, there has been continued, gradual progress in lowering inflation, and moderation in wage growth. This is great news, and while I tend to be an optimist, things are looking a little too good to be true, so it makes me think that something’s gotta give. Either growth moderates, fostering conditions that support continued progress toward our 2 percent inflation objective, or growth doesn’t, possibly undermining that progress. But which is going to give—the real side of the economy or the nominal side?

Waller’s latest update (see Something Appears to Be Giving) observed that “something appears to be giving, and it’s the pace of the economy”. Waller has been seen as a hawk and this speech was a signal that there is little appetite for further rate hikes. In a subsequent Q&A, Waller addressed the issue of rate cuts: “If you see this [lower] inflation continuing for several more months, I don’t know how long that might be—three months? four months? five months? You could then start lowering the policy rate because inflation’s lower.”


In other words, if monthly core PCE continues to print at 0.2% for 3–5 months, the Fed would start to cut rates as it’s becoming evident that inflation is moving toward its 2% target.



Fed Chair Jerome Powell also underlined Waller’s signal that the Fed is done raising rates in a speech made last Friday.

The strong actions we have taken have moved our policy rate well into restrictive territory, meaning that tight monetary policy is putting downward pressure on economic activity and inflation…Having come so far so quickly, the FOMC is moving forward carefully, as the risks of under- and over-tightening are becoming more balanced.