The Cost Of Fear

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The price of gold entered a bear market in early 2013 when it broke down out of a 13-month shelf.

That shelf could have been a high level consolidation or distribution.

Counting from the September 2011 top in gold, the 3rd lower weekly high in September 2012 was the death knell.

Fast moves are often derived from 3rd lower weekly highs.

From September 2012 to June 2013, GLD spiraled from 174 to 115.

This represents a 360 degree move plus a 90 degree overshoot.

There hasn't been any clear correlation between gold and central banks' total assets since the 2011 top.

Indeed, gold made a final pivot high as offered above in September 2012 and entered a bear market shortly thereafter when the BoJ adopted a MORE aggressive stance associated with Abenomics and the growth of its monetary base accelerated — just as gold peaked in in the fall of 2011 in league with more QE implemented by the Fed.

One of the most important concepts in financial markets is not to confuse cause with correlation.

While most subscribe to the notion that there is an inverse historical relationship between gold and the dollar, it is wise to view both markets independently according to their own price structures.

There are no rules in this came: fear can drive both higher in tandem.

Arguably, a case can be made that fear that has been driving the dollar higher as the world reserve currency based on fear of the EU
breaking up with a referendum in Italy and an election in France front and center.

At the same time yields ratcheting higher are driving the dollar higher.

U.S. 10-year note yields posted their largest increase since July 2013.

Higher U.S. yields are raising the value of the dollar by making dollar-denominated assets more attractive to investors.

Fear of rising inflation tends to erode the value of bonds, increasing yields.

In turn, so goes the argument is that higher U.S. interest rates raise the value of the dollar by making dollar-denominated assets such as bonds more attractive.

However, the T- Rex in the ointment is how fast bonds decline (with yields rising inversely).

If bonds toboggan as they have been, then investors may hold back on buying then if they think yields are heading materially higher.

The acceleration in U.S. yields since the election may not just be a knee-jerk reaction of optimism to fiscal stimulus and the promise of growth under Trumponomics and Republican control of Congress.

One driver may be concern that bonds are selling off due to fears of America's creditworthiness under a President Trump.

The real tailwind for gold is distrust in government. Distrust has a funny way of turning to fear.

Underscoring the idea of fear driving the dollar as well is that recently the Bank for International Settlements reported that the US dollar has replaced the volatility index as the new fear index.

This new dynamic in the dollar is pushing international borrowers and investors toward the dollar.

Distressingly, dollar appreciation is occurring at the same time US fundamentals are eroding: foreign central banks sold nearly $375 billion in US Treasuries in the past year.

Another factor driving the dollar higher is that the ECB and many emerging markets central banks have borrowed in dollars to fund their purchases, resulting in the dollar being the biggest short out there.

This is a double whammy: the dollar has ripped higher at the same time as interest rates impacting the cost of borrowing the dollar.

Below are weekly and daily charts of gold and the XAU which suggest a setup to bottom in this time frame on the one-year cycle.