Sprott Gold Report: Summer Test

By Trey Reik, Senior Portfolio Manager, Sprott Asset Management USA, Inc.

Gold is never easy. So many factors influence the gold price, it is impossible to predict bullion’s short-term reactions to individual economic or geopolitical developments. To us at Sprott, gold’s portfolio utility is shaped by long-term fundamentals and epic structural imbalances. Excessive global debt and related monetary debasement have been decades in the making. There will be no quick fix for a global economy weened on emergency liquidity. Given economic pain implicit in debt rationalization, central banks will always strive to delay the inevitable recalibration of bloated financial claims to underlying productive output.

In the meantime, gold remains a potent portfolio diversifier buffeted by a steady stream of short-term trading cues and knee-jerk reactions. Without question, the most trying times for gold investors are periods when big picture fundamentals are aligning solidly in gold’s favor, yet the market chooses to trade gold based on perceived correlations with short-term movements in other asset classes.


In our decades in the investment business, we have learned that at least in the short run, the market is never wrong. Given our analysis of macro and monetary fundamentals which we have tracked for over fifteen years, we are a bit stunned by gold’s performance during the past few months and provide an in-depth analysis below. It is neither the first nor the last time we will be humbled by gold’s uncompromising autonomy. As my wife occasionally consoles me, “gold is not a trained seal.”Nonetheless, we maintain high confidence that a portfolio commitment to gold offers enormous portfolio utility in today’s complex and treacherous investment environment.

We have been encouraging Sprott clients to exploit summer price movements in precious metals to their maximum advantage. An extraordinary opportunity is now presenting itself.


The summer of 2018 has shaped up to be a frustrating stretch. The Fed’s dual policy agenda of simultaneous rate hikes and balance sheet reductions has ratcheted-up peripheral financial stress at a pace faster even than we had anticipated. To date, though, cognitive dissonance over the U.S. dollar’s contributing role has preserved its safe harbor status. As the scale of emerging markets dislocation expands on a weekly basis, the stored force in collapsing EM currencies is still funneling towards a strengthening dollar, and in turn reflexively pressuring the gold price. Even the weekly circus of President Trump’s impetuous tariff crusade, as unsettling as it has been for market confidence, has thus far weighed on gold through the tractor beam of a collapsing commodity complex. Do the headlines of the past three months really suggest gold’s portfolio merits are diminishing?

As shown in Figure 1, from year-end 2016 through 4/16/18, a 12.5% decline in the DXY Dollar Index supported a methodical 16.8% gain for spot gold. Then in mid-April of this year, everything changed. All of a sudden, the U.S. dollar regained its mojo, bolstered by 10-year U.S. Treasury yields surging through 3%, a hawkish Federal Open Market Committee (FOMC), favorable global capital flows, strong S&P earnings and whispers of 5% Q2 GDP growth. Since the dollar’s 4/16/18 turn, the DXY Index has rallied a crisp 8.1% through 8/15/18, while spot gold has retreated 12.7%.

Figure 1: U.S. Dollar Regains its Mojo in April 2018. Source: Spot Gold vs. DXY Dollar Index (1/2/17-8/15/18), Bloomberg. The U.S. Dollar Index (DXY) is a measure of the value of the United States dollar relative to a basket of foreign currencies.

As we discussed in our July report (Tariff Tension), gold’s prospects for the balance of 2018 and beyond will be heavily influenced by the U.S. dollar’s relative strength.

Updating the list of factors we cited for the dollar’s mid-April turnaround, 10-year Treasury yields have already retreated back below 3% (ominously in concert with a collapsing yield curve), the FOMC is having to resort to unprecedented measures to keep the effective fed funds rate from squirting above its targeted range, strong S&P earnings are being exposed as the reciprocal of an exploding federal budget deficit and reported Q2 GDP growth turned out to be fairly lame in the context of super-charged fiscal stimulus.

Despite gold’s star-crossed performance during the past three months, we remain confident that the U.S. dollar’s summer strength will soon prove to have been a countertrend rally within an extended decline.

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