New gold bull market or bear market rally?

Gold has rebounded strongly in recent weeks as the generalised inflation panic has built up a head of steam. It has been particularly helped by the peculiar combination of high US inflation and a weakening DXY, trigger by the recent US jobs report which hinted at stagflation.

This has led to a slump in real interest rates and driven gold back up:

Goldman has more on the dynamic:

After a record inflation surprise in the US, traded inflation has topped multi-year highs across maturities – US 5yr and10yr breakevens are at their highest level since the GFC,2.7% and 2.5% respectively. Based on market-implied probabilities, the likelihood of inflation overshooting the Fed target for longer has surged to a record high (Exhibit 1) and inflation risk premia have turned positive vs. the last cycle when markets were pricing deflation risk (Exhibit 2).

Although the cross-asset response to recent macro data surprises has been mixed, markets seem to have broadly repriced inflation and rates risk, with equities and bonds closing the week in negative territory. Concerns onsupplyconstraintsandUS peak growth have added to the risk-off reaction. Long-duration assets have particularly suffered alongside EM assets, while value, financials and gold have outperformed (Exhibit 3).

US 10yr rates have been responsive to the CPI release and moved higher driven by breakevens, exacerbating the sell-off that re-started in mid-April. A comparison of cross-asset performance in the rates sell-off from February to March vs.the current one shows the main beneficiaries of higher inflation, namely commodities and value, have outperformed their beta to US rates in both instances (Exhibit 4) after lagging before. However, differently from March, real rates are now trading flat to down. This, alongside some risk-off concerns as markets are dissecting the inflation risk with growth momentum fading past the peak, has likely supported the recent gold outperformance. Despite lower real rates, the rotation out of Tech stocks has continued -the performance of Nasdaq relative to the S&P 500 has decoupled from real rates which it tends to be closely linked to historically (Exhibit 5).

While the April CPI spike does not affect our long-term view as our economists expect it to be temporary, inflation concerns are likely to linger over the next few months and into year-end. This represents a key risk for multi-asset portfolios as both equities and bonds might suffer in this scenario. Thus, we still consider adding selective exposure to inflationary hedges – we like energy equity, which has seen robust 2021E EPS revisions, energy FX such asUSD/CAD, commodities as our strategists reiterate their bullish stance on copper and oil, and Value. Additionally, based on our long-term analysis across inflation regimes, Gold tends to perform well when realised inflation is elevated and rising, while the Dollar suffers, especially asthe Fed stays on hold as in our base case (Exhibit 6).

I am still of the view that inflation pop is temporary and will fall hard in H2, as well as into 2022 as commodity prices crash with sharply slowing Chinese growth. So that puts paid to gold in my view as real interest rates will rebound.

Worse, I do think that US inflation will be stronger than just about everywhere else through the cycle as its fiscally-led labour market tightens while China deflates itself, dragging the EM complex and Europe down with it.

This leads me to conclude that the Fed will lead the global tightening and DXY will remain strong.

These are the conditions for a gold bear market.

Houses and Holes
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