I am reiterating my bullish view on gold. Gold staged an upside breakout through a cup-and-handle pattern at 2100 in early 2024 and hasn’t looked back since. Moreover, it has staged upside relative breakouts against both the S&P 500 and a 60/40 proxy and it has stayed above the relative breakout levels even after the recent pullback. The technical pattern of multi-year bases and subsequent absolute and relative breakouts is highly reminiscent of the pattern experienced by gold at the start of the 21st Century, which took the yellow metal from its breakout at 500 in 2004 to significant higher prices.
I believe this is just the start of a secular bull cycle for gold prices, based on a secular Sell America investment cycle.
Sell America = Gold Tailwind
The recent market embrace of the Sell America investment theme has given gold prices a significant secular tailwind. That’s because Trump’s abrupt pivot to an isolationist policy has shaken confidence in the status of American geopolitical leadership and the status of the USD “exorbitant privilege”. In late March, I wrote (see Uncharted Investor Waters: From Soft to Hard Power).
Trump’s ultimate game plan is to reshore manufacturing by reversing the effects of globalization. He has implemented an approach of harvesting the goodwill from U.S. alliances since the end of World War II, and through the implementation of trade barriers and economic pro-growth policies.
The long-term costs of these policies are the probable stall in productivity, and an increase in the cost of capital to U.S. companies through the removal of the USD’s “exorbitant privilege” as a reserve currency.
The Moody’s downgrade of U.S. debt from Aaa to Aa1 underlines a number of stress points that are rattling the bond and currency markets, as well as the points I made about the loss of “exorbitant privilege”.
- Deficits are projected to grow as entitlement spending rises and revenue stays flat.
- Ongoing fiscal deficits are exacerbating a supply-demand imbalance in Treasuries.
- The inflationary effects of the trade war could see a hawkish Fed against a dovish backdrop by other major central banks, which will reduce the relative growth potential of the U.S. economy against the rest of the world.
- Possible U.S. policy changes will see investors demand a higher premium for U.S. Treasury debt in the face of increasingly unfriendly tax treatment and rising uncertainty.
Do Deficits Matter?
President Trump and the Republican-controlled Congress have been operating under the age-old assumption that deficits don’t matter. I would add that “deficits don’t matter – until the day they do”.
Bond rating agencies, as well as the market, may be telling the U.S. Treasury that budgets are about to matter. Consider the budget proposals making their way through Congress. Without going into too many details that will still have to be ironed out, the accompanying chart shows the effects of the budget proposals on the deficit. As it is the case with virtually all budgetary math projections, the budget plan frontloads the benefits (tax cuts) and backloads the politically painful spending cuts. This will have a fiscal stimulative effect on the economy in the first two years, which is potentially equity bullish, while risking bond and foreign currency tantrums.
A Penn Wharton budget analysis of the budget proposals, as presented, would increase the deficit by $3.3 trillion over 10 years. However, some of the provisions of the budget expire in 2029. If those provisions were to be extended, an alternative analysis shows a deficit of $4.8 trillion over the same time frame.
The projections depend on two key assumptions: 1) Stable debt costs, which would spike the overall deficit as interest rates rise; and 2) the absence of a recession, which would crater tax revenue and spike the deficit.
Here is why deficits may start to matter as Treasury supply-demand imbalances become evident. Brad Setser documented how official demand for Treasuries have been falling.
In general, bond inflows have also been falling. Setser rhetorically asked if the flows can return to the $1-trillion annual pace, which would sustain a 4% of GDP funding level, or stay at the $500 billion level. Setser concluded, “I do think it is fair to note that increasing a 6.5% of GDP fiscal deficit into…waning foreign demand for coupons is a well, somewhat bold, move”.
Jens Nordvig, the CEO of Exante Data, had an even more alarming observation. U.S. real yields are spiking even as economic growth expectations are falling. These are indications that the market is losing confidence in the U.S. and U.S. exceptionalism.
The Fed Policy Wildcard
Meanwhile, over at the Federal Reserve, policy makers have adopted a cautious approach to monetary policy. While falling inflation indicators would ordinarily warrant interest cuts in the near future, the uncertain effects of the new tariff regime on inflation has resulted in a go-slow and wait for the data approach to interest rate policy.
The most disturbing development is the May University of Michigan survey of one-year inflation expectations, which spike to an astounding level of 7.3% and long-run inflation expectations rose from 4.4% to 4.6%. While the University of Michigan survey might be dismissed a data anomaly, the New York Fed survey of one-year inflation expectations has been slowly ticking up. These results raise the risk of inflation expectations becoming unanchored and force FOMC members to tilt more hawkishly.
As well, Robin Brooks highlighted a growing divergence between the bond market’s inflation expectations in the U.S. and eurozone. While eurozone expectations have been largely flat, U.S. expectations are rising. This will lead to a divergence in monetary policy. The European Central Bank (and other central banks) will ease, while the Fed stays tight. The glass half-full interpretation is that interest rate differentials should boost the value of the USD, while the glass half-empty interpretation is a perceived economic growth differential between the U.S. and the rest of the world, which is bearish for the USD and U.S. assets.
In summary, this leaves U.S. fiscal and monetary policy in a difficult position as it’s exposed to rising tail-risk. If fiscal policy is too easy, it risks a bond and foreign currency tantrum that leads to a drop in the USD and rising bond yields. On the other hand, if fiscal or monetary policy is too tight, it risks a recession, which rapidly expands the deficit and the fiscal sustainability questions raised by Moody’s and other rating agencies that downgraded U.S. debt.
Other Policy Risks
As well, two policy initiatives considered by the Trump Administration have the effect of either reducing demand for USD assets or causing investors to require a higher yield for holding Treasury paper. In addition to putting upward pressure on yields, these policies would put downward pressure on the USD.
One proposed provision of the new tax bill, Section 899, increases the tax rate on countries that “unfairly target and burden U.S. businesses and individuals operating abroad” based on the imposition of an “unfair foreign tax”, such as a tax on digital services and a global minimum tax. It raises the U.S. federal tax rate by 5% to 20% on tax residents of offending countries and has language that overrides existing tax treaties. The new rates would apply to passive U.S. source income such as dividends, interest, royalties and rents, as well as active U.S. operating income.
At a minimum, an enacted Section 899 of the tax code would impose a tax on interest income such as Treasury and Agency paper on investment by entities tax domiciled in jurisdictions with “unfair foreign taxes”, such as the EU which is part of the global foreign tax regime agreed to in the past. It effectively deters foreigners from holding Treasury paper and reduces their demand.
Oops. That’s one way of encouraging capital flight and depressing the USD.
In addition, the Moody’s downgrade of U.S. debt from Aaa to Aa1 with a stable outlook depends on some key assumptions that may be overly sanguine about U.S. policy direction. First, it checks the boxes by focusing on debt levels and debt servicing capacity relative to other top-rated sovereign issuers. It also raised concerns about rising spending based on demographics while revenue stays flat.
One of the rationales for a stable outlook is the assumption that “the U.S. will continue its long history of very effective monetary policy led by an independent Federal Reserve”. It added, “Underpinning the rating is our assumption that…monetary and macroeconomic policy effectiveness will remain very strong, preserving macroeconomic and financial stability through business cycles.”
Jerome Powell’s term as Fed Chair will end in May 2026. Can investors expect a similar level of Fed independence once he has left? The market’s attention will turn to his replacement in H2 2025, which is the probable time frame the new Fed Chair will be nominated. Trump has criticized Powell several times in the past for being too slow to cut interest rates.
In the meantime, Fed Chair Jerome Powell addressed the current climate of uncertainty in a
recent speech and signaled that the Fed may take a more hawkish stance on monetary policy: “Longer-term interest rates are a good deal higher now [compared to 2020] … [and] may also reflect the possibility that inflation could be more volatile going forward than in the inter-crisis period of the 2010s. We may be entering a period of more frequent, and potentially more persistent, supply shocks—a difficult challenge for the economy and for central banks.” Other FOMC members, such as Atlanta Fed President Raphael Bostic supported Powell’s cautious view and warned that “the economy may be on the brink of price-hike wave”.
The next Fed Chair is likely to bring a more dovish perspective to monetary policy, especially if a Republican is in the White House. Leading candidates like Kevin Warsh and Judy Shelton fit this template perfectly.
Would a Warsh or Shelton Fed be able to maintain the same level of credibility with the markets as previous Fed Chairs stretching from Volcker to Powell? What if inflation rates were to rise as tariffs have their effect on pricing levels? Does that risk a Liz Truss moment in the U.S.?
Already, the market’s inflation expectations have staged an upside breakout. The potential combination of a stimulative fiscal and monetary policy has the potential to really rattle markets.
Bullish on Gold
In conclusion, the Sell America investment theme is becoming a dominant market narrative, and it’s bearish for USD assets and therefore bullish for gold. It is driven by the combination of rising deficits, shaky bond markets, an increasingly hawkish Fed and policy uncertainty.
I believe gold is just in the early stages of its secular bull. The bull run will not end until psychology changes and the mom-and-pop investor piles in. Current retail demand is mainly driven by the Asian investor and U.S. and European investors are nowhere to be seen.
As well, global family office allocations to gold and precious metals in 2025 was only 2%. Market tops don’t look like this.
For a long-term perspective of the upside potential in gold, a point-and-figure chart of monthly gold prices, using a 5% box size and 3-box reversal, shows a measured objective of almost $7,000. I interpret this as an indication that the gold bull is only starting and it has several years to go before it reaches a final top.
Tactically, the gold mining stocks staged an upside breakout from a bull flag, which is a continuation pattern, after its 14-day RSI neared the 40 level, which is where it bottomed in the recent past. Market internals, such as the gold miner to gold ratio and percentage bullish, are showing neutral readings. These are indications of further short-term upside potential.
Disclosure: Long GDX
