Gold: A new trading range or a new bull market?

My fascination with gold is inextricably intertwined with my boyhood in Dubai in the early 1980’s. Dubai was one of the world’s great gold trading hubs of the Middle East, its political stability, minimal taxes and laissez-faire policies a magnet for some of the world’s top gold dealers. Back then, Beirut was mired in a vicious civil war, Bahrain’s focus was on offshore banking and not bullion, Istanbul was crippled by hyperinflation and political violence, Karachi was traumatized by a military coup d’état led by an Islamist dictator and Mumbai choked by capital controls/Indira Gandhi’s socialist policies and South Africa was isolated from the world by sanctions on the Afrikaner apartheid regime in Pretoria.

This was Dubai’s moment to become a trading hub in the global gold souk. So Dubai emerged as one of the world’s top five bullion exporters even though the nearest gold mine is five thousand miles away. By a stroke of luck, my father’s family friends included the late Haji Ashraf and Abdel Wahab Galadari, two of the world’s most powerful gold traders of the 1980’s, twin legends of Planet Auric, who would bid in IMF gold auctions and move commodity futures markets from Hong Kong to Manhattan, London to Chicago. I know. I was there. My real education in global finance began as a teenager in the Deira Gold Souk, not in the classrooms of Penn and Wharton.

Gold seems to have broken out of its mediocre trading range in the past month. Gold trades at 1412 as I write, a six year high, boosted by Wall Street’s conviction that the Powell Fed will cut rates by 50 basis points, capital flight from Hong Kong, the slippage in the US Dollar Index from its recent 98 high, trade tensions between the US and China and rising geopolitical risk in the Arabian Gulf.

Yet I remember the 40% plunge since gold last peaked at 1930 an ounce in September 2011 all too well. I concede we are in a higher trading range but I am not convinced that the yellow metal is in a new bull market – nothing comparable to the one I witnessed in my Dubai boyhood when the US dollar was in free fall, the Shah had just lost his Peacock Throne and Leonid Brezhnev’s Soviet Union had invaded Afghanistan. A higher trading range is not a secular bull market even if gold rises to $1500 an ounce. So what macro variables could be the catalyst for a new gold bull market?

One, will the trade war turn into a currency war? If China and the US engage in competitive devaluations, gold will go ballistic as a classic safe haven, a hedge against central bank monetary manipulation. The truce in Osaka is tactical and does not rule out a currency war.

Two, will the Powell Fed, the Draghi ECB and the Kuroda-san Bank of Japan ease monetary policy at full throttle? If the Federal Reserve cuts interest rates by 75 basis points by early 2020, as the Chicago Fed Funds/Eurodollar futures curve implies, gold prices will surge. This scenario is possible if US-China trade talks irrevocably break down or the Chinese economic slump/US nonfarm payroll dip morphs into something far uglier.

Three, the world’s geopolitical risks could escalate – Iran, Syria, Hong Kong, North Korea and Venezuela are the obvious flashpoints.

Four, will central banks accumulate gold reserves as a hedge against America’s deliberate attempt to push the US dollar lower, after nine Fed rate hikes since December 2015? Note that China and Russia have tripled their holdings of gold in the past decade even as they slashed their portfolios of US Treasury bills, notes and bonds.

Five, will US Treasury note yields continue to fall at an accelerating rate at a time when German, Swiss, Japanese and Dutch government bonds trade at negative yields? Since gold offers no yield, its price rises when government bond yields fall. What if the US economy slips into recession and the Powell Fed is forced to engineer negative real interest rates – six rate cuts, not the three priced into Chicago money market futures. Gold’s inverse correlation to the US dollar rises in such a macro scenario.

Six, will an oil shock or central bank policy mistake lead to a rise in inflation expectations? Gold has now begun to outperform even the stellar return in the 10-year Treasury note now that its yield has tanked to 2.01% from 3.25% last October. In the past, this has been a useful advance indicator of a rise in short term inflation. If there was ever a time to sell long term bonds, this is it, as it was in December 2008 and March 2016. My call? Auric rocks and may the force be with you, my tribe of wannabe Dr. Goldfingers-but gold is not yet in a bull market!