Gold Has Reached Its Most Stretched Valuation in Decades
I was bullish on gold for decades, right up until this year. Now I am off that horse. The reason is simple: gold's relative value is horrible.
Gold should bounce from $4,000 an ounce. That was fully expected, and it did bounce, reaching $4,350. The real question is whether it can climb above $4,500. That number matters because it is the 200-day moving average, the average price over the last 200 days. In a real bull market, prices are not supposed to trade below that line. Gold sits below its 200-day average and has already rolled over. Bitcoin has stayed below its own 200-day average for about 8 months. The pattern is the same.
Gold is a store of value that pays you no income. You dig a rock out of the ground and put it back in the ground, to borrow Warren Buffett's words. This year gold hit its most extreme level versus its 10-year moving average almost in history. You have to go back to 1980 to find something similar. If gold cannot reclaim its 200-day average, the bounce from $4,000 is camouflage, not confirmation. Chasing that strength could create needless downside.
The Yield Problem: 5% Treasuries Beat a Rock
Gold faces a rare problem. Its biggest competitor now pays you to hold it. Investors can sell a rock and buy Treasuries for a guaranteed 5% return. That changes the whole risk math, because money can now demand income instead of hoping for price gains.
Gold sits at its highest level versus a basket of US Treasuries in 40 years. The US 30-year yield is the highest in 25 years. The last time the 10-year bond yield hit 5.21%, gold was bottoming from its steepest discount to its 10-year moving average almost in history. Now the reverse is true: gold is at its highest level versus that moving average in at least 40 years, maybe close to 50. This is not a level to be overweight gold. Those of us bullish forever should have seen this year as the chance to get out.
The T-Bond to Gold Ratio: A Four-Decade Extreme
The core trade is a ratio of Treasury bonds to gold. I have been too early on it. Using a Treasury long-bond index that goes back to 1973 and dividing by the price of gold, we are at the lowest level since 1987, which was a unique year.
Earlier this year, Treasuries got much cheaper versus gold. Now that ratio is tilting back up. Right now both are roughly flat: long bonds are down about 2% to 3% on the year in total return, and gold just popped up to near unchanged. If that ratio flips higher and bonds start beating gold, that is a huge trade, potentially bottoming from a four-decade extreme.
The Real Story Is the Stock Market
Everything comes back to the stock market. If it keeps advancing, fine. But once we see a little normalization, these high bond yields have the number one force pushing them lower. The Fed won't have to tighten, and may even consider easing. Rinse and repeat.
The S&P 500 versus GDP, on an end-of-year basis, is the highest since 1928. The S&P 500 versus public debt is the highest since 2000. The stock market is now 2.5 times GDP. The stock market has become the economy. It is all that matters, a 10 on a 1-to-10 scale, and it has to keep going up.
Today's payroll number was insignificant. Unemployment dropped to 4.1%, where it has hovered for about 2 years. Payrolls dropped 23,000, which is nothing and will probably be revised away. None of it matters next to what the stock market does.
The one problem with a stock market this high is inflation. It creates excess inflation, which is probably a sign of the endgame, because inflation is now the number one issue in the election. Here is the key point: if Trump does not fix the inflation problem by the midterms, he gets hammered. That is done. And if it is not fixed by the 2028 elections, the next president is virtually guaranteed to be a Democratic socialist, like the mayor now in New York City and the mayor in Miami.
How Long Gold Could Stay Below Its High
After extremes like this, recovery takes years. The 1980 gold high was around $800, and it took until about 2007 or 2008 to take that out. Silver's 2011 high, much less stretched than gold is now, took until about 2024 to exceed, really around 2000. Today gold is the most stretched by many measures in 40 to 50 years. The danger is not just falling prices. It is capital getting trapped while better opportunities show up elsewhere. Sometimes the hardest trade for a lifelong bull is simply getting out.
China's Oil Demand and the EV Shift
China's crude oil imports have rolled over and plunged. At the same time China shows severe deflationary forces, with the 10-year note yield at 1.71%. China sold high and bought low to load up its strategic petroleum reserve.
The bigger shift is in crude oil demand itself. Using Bloomberg's AI model, ASKB, I found that around 62% of auto sales in China are now electrified, including plug-in hybrids, not all pure EVs. That attacks petroleum at its source, since transportation is the historical demand puller for oil. On top of that, China's auto sales are declining. A 12-month average shows them rolling over faster than in 2018 and 2019, from a decent peak. Brent crude probably peaked at a lower high. What crude normally does in this setup is fall toward $40, driven by surplus supply and production shifting from the Middle East to the Western Hemisphere, with drilling running from Canada to Argentina, plus the US and Venezuela in between.
China has a deficit of fossil fuels but a massive surplus of technology. It is spreading that technology and its deflationary force around the world. That should keep pressuring crude oil, though it has been a bullish factor for copper, and it is a question how long that can last.
The 2008 and 1929 Parallels
The Bloomberg Commodity Index is on the exact same pace as 2008. That year the commodity spot index pumped about 30% and ended the year down 30%, on the back of record highs in crude oil and natural gas. This year energy pumped, but crude and natural gas put in lower highs, much lower for natural gas, which faces major oversupply and is already heading down. The market is already rolling over.
Gold's annualized volatility is 2.1 times that of the S&P 500. The last time it was that extreme was 2007. Correlations between gold and the S&P 500 are running near the highest ever in an up market for stocks. That is a warning: when your hedge starts moving with stocks, diversification breaks down and gold behaves like another risk asset in a selloff. This year we have seen pumps then dumps in Bitcoin, natural gas, gold, silver, platinum, and corn.
For 1929, the S&P 500 is on pace, actually lagging a little. That year the S&P peaked up around 30% and ended down 12%. Not huge, but it marked the pump before the crash. We are melting up now, and it is only August, maybe running into September or October before everything runs away. One difference: back then the New York Fed started tightening a little. Today the Fed is already focused on tightening but not doing it.
What Looks Attractive Now: Cash and Bonds
I like cash and bonds, little else. As a trader I looked at the January natural gas contract, which dropped to near $4, probably a decent support level. Its high was around $5.65, and it just hit the lowest level since Russia invaded Ukraine. January is usually the apex of the bell curve for gas, so expect responsive buying there. If it holds below $4, that is your deflationary signal.
My approach this year has stayed the same: be responsive and sell things that got expensive. Bitcoin was on my radar near $100,000; now it is at $64,000 after a high this year around $96,000. Silver was above $100 on my radar; now it is around $63 an ounce, so that has already worked. One thing I got wrong is copper. I did not think it could stay above $6 per pound; it is now at $6.60, and I am down about 10% on that call, though I am not actually trading it.
The link across silver, gold, Bitcoin, and copper is that they need the stock market to go up, and they have been underperforming. Copper is the most important one in commodities; it has to stay up. My bias is that volatility should pick up in the stock market, which has happened a little, but in an up market. Toward year end, the only place left for alpha is bonds. Compliance has never stopped me from saying overweight Treasury; the only question is how far out on the curve you go.
The Bond Setup and the Fed's Escape Hatch
The long bond is at a 25-year extreme low in price. Ending the year at a 25-year high is unlikely, but the setup is powerful. The Fed faces an endgame: it has to do something about inflation, or the markets do it for them. The easiest path is for markets to do the tightening.
Imagine just a 10% pullback in the stock market. It goes near unchanged on the year, and the inflation problems vanish. The Fed could then even start considering easing. That is the number one thing that matters now. After the last Fed meeting I got annoyed at all the predictions about a Fed that is not going to do anything. From the Fed's standpoint right now it is much ado about nothing. They are supposed to stay vigilant against inflation, but the cleanest outcome is a small stock market drop that eases inflation globally without aggressive Fed action.
That creates a strange setup: falling stocks could become bullish for Treasury prices. Bonds have already started doing the tightening. I think Bessent gets it. If a small equity decline happens, all these forces kick in, and we have a trade of a lifetime potentially kicking in.
