Sure, it’s shiny, but what is it really worth?

Stocks crawled higher yesterday as traders eagerly await important economic data – NVIDIA’s earnings report, due this afternoon. Consumer Confidence jumped higher, beating economists’ expectations, boosting the chances of a soft-landing scenario.

Bucking the trend. So, here we are. The biggest news, or rather, potential news in stocks is what NVIDIA will report this afternoon when it delivers its Q2 earnings. It also is, apparently, the biggest news in the economics release calendar; you won’t have to search too far these past two days of market newsletters to find some mention of NVIDIA. Oops, I think that I even mentioned it in yesterday’s note, and here I am at it once again, today. Well, enough of that, let’s focus on another recent, rising star this morning.

Did you guess that I was going to talk about gold? Gold is one of those things that you are happy to have in your portfolio some days, but not most days… historically, that is. It is typically held as a hedge against disaster and inflation. Historically, when stuff hit the fan investors would rush into it as a safe-haven investment. I suppose if world order completely collapsed… I mean really collapsed…people would be able to trade ingots of it for goods. I mean who doesn’t want to own a lump of soft, shiny metal good for making elaborate jewelry. Sure, its highly conductive properties make it useful in production of hardware like printed circuit board and semiconductors, but that would not likely hold in a doomsday scenario.

From an inflation standpoint, there are some technical things which make gold a historical go-to investment, but that relationship is harder to track. Suffice it to say that traders bought gold historically during times of high inflation – for whatever reason – causing the commodity to rise. That should be good enough, right? Well, if that were the case today, why then is gold going gangbusters while inflation has been shrinking? Oh, you haven’t heard? Gold is at all-time highs. How can that be, you may be wondering? While the world is certainly not in perfect harmony, there have been no recent signs of imminent collapse. And, as aforementioned, inflation has been receding globally.

Before I go further into this, it is important to mention that gold trade is very liquid. You can turn it into currency very easily and you can also buy it quite easily. Keep that thought for a second. So, if you want to avoid having huge stacks of bank notes sitting in your safe or under your mattress, you can simply by bricks of gold for easy storage. Oh, and it doesn’t corrode, while paper money can be easily damaged. Ok, so now you know about some of its important qualities, but that still doesn’t explain why it has recently jumped so high in value. Why are people buying it? Well, gold doesn’t pay dividends, so, from an investment perspective a beneficial owner can only earn returns if it goes up in value.

Well, it is highly likely that the US dollar has something to do with it. As it has become clearer that interest rates in the US are going lower, the value of the dollar relative to other currencies has been going down. You see, funds follow sovereign bond yields always searching for the highest return in the strongest economy. For a while the US dollar was quite strong with high Treasury yields and a healthy economy. But as yields started to come down, investors began to seek yield elsewhere, in different markets… WITH DIFFERENT CURRENCIES. Shifting those investments requires an investor to exchange currencies, in essence, selling US Dollars to buy a currency in the market they wish to invest in. That is classic economics. But there has been something else putting pressure on the greenback. Remember that really tough Monday a few weeks back? If you don’t, it’s ok, I will remind you that your favorite stocks all tanked, following a precipitous decline in the Japanese stock market. Oh, now you remember. Everyone was talking about a carry trade unwind as the culprit. I am not going to get into it here as I covered it in earlier notes and online videos. At a high level, though, traders were borrowing money in Japan’s negative interest rate environment, converting into, say dollars, and buying investments that were yielding more than their cost of investment. When the Bank of Japan decided to raise its key lending rate earlier this month (for a second time), investors decided to unwind their trades as the cost of borrowing went up. To do that, they sold their dollar-based investments and had to convert back to the Japanese Yen to pay off their loans. Converting meant, literally, selling US Dollars and buying Japanese Yen. The key there is SELLING US Dollars, and that caused a decline in the currency.

OK, so going back to gold, what does that have to do with gold’s recent, jubilant ascent? You were patient, now I will deliver the punch line. Gold is traded in US dollars… for everyone on the international stage. So, a jewelry manufacturer in India wishing to purchase large sums of gold must first convert their Rupee to Dollars in order to purchase the gold. Guess what, with the weaker dollar, caused by all that stuff I mentioned in the last paragraph ☝️, gold is cheaper to foreign buyers based on the exchange rate. Because it is cheaper, demand increases, and when demand for gold increases… its price goes up. So, folks who hold gold in their portfolios as a hedge, got an unexpected windfall. Oh, and those folks who like to hold bars of it in their safes… also got a windfall. They can thank Jerome Powell and carry traders. Check out the bonus chart that follows to see the inverse relationship between the dollar and gold.

YESTERDAY’S MARKETS

NEXT UP

• MBA Mortgage Applications (August 23rd) increased by +0.5% after declining by -10.1% last week.
• Fed speakers today: Raphael Bostic and Christopher Waller.
• This morning, Foot Locker beat on Sales and EPS, while Bath & Body Works, JM Smucker, and Kohl’s missed the mark. After the closing bell, we will hear from Salesforce, Five Below, HP, Applied Digital, Pure Storage, Victoria’s Secret, Affirm, Crowdstrike, and Okta. However, all eyes will be on NVIDIA, which is expected to deliver earnings at 14:20 Wall Street Time.