Gold continues its ascent to higher pricing

On the second trading day of the year gold futures most active, February 2021 Comex contract is fixed at $1952.60. Although today’s gains were meager when compared to yesterday’s dramatic $50 price advance, the importance of today’s gains has to do more with follow-through buying after a stellar performance yesterday, rather than traders moving in to quickly take profits.

When the daily gains in gold are extremely strong, typically professionals and money managers use that opportunity to take profits, which did not occur on this occasion. That implies that the majority of market participants are overwhelmingly bullish believing that gold will continue to gain value throughout the first and second quarter of this year.

Yesterday’s gains were aided by a sharp selloff in U.S. equities moving market sentiment slightly from a risk-on demeanor into the safe-haven asset class. This is a basic rule that is at the core belief of liquidity theory.

According to Investopedia, “Liquidity Preference Theory is a model that suggests that an investor should demand a higher interest rate or premium on securities with long-term maturities that carry greater risk because, all other factors being equal, investors prefer cash or other highly liquid holdings.”

In other words, investors will allocate funds to a stock or asset class they believe has the greatest potential return. This theory was mentioned by the famous economist John Maynard Keynes in his book “The General Theory of Employment, Interest, and Money (1936)”.

John Maynard Keynes is the creator and author of Keynesian Economics. This theory is the predominant technique that is currently used by economists worldwide including the Federal Reserve and all the major central banks. The theory was first developed in the 1930s as an effective technique to rebuild economies worldwide after the Great Depression, which by all measures was the greatest and longest economic recession in the history of the modern world.

Investopedia explains Keynesian economics as a "demand-side" theory that focuses on changes in the economy over the short run. Keynes’s theory was the first to sharply separate the study of economic behavior and markets based on individual incentives from the study of broad national economic aggregate variables and constructs. 

This technique is a proponent of governments increasing their capital expenditure to produce greater aggregate output which in turn will generate more income. His theories have become the playbook by which the Federal Reserve uses and accommodative monetary policy and low-interest rates to aid in an economy expand and flourish.

Currently, the global pandemic has affected economies worldwide. As such major central banks including the Federal Reserve have been adding massive liquidity by purchasing approximately $120 billion worth of mortgage-backed securities every month and keeping their Fed funds rate (the Fed target interest rate at which commercial banks borrow and lend their excess reserves to each other). Intrinsically this action when coupled with the trillions of dollars of capital spent by the U.S. Treasury Department has had a dramatic and devastating impact on the value of the U.S. dollar.

Since the middle of March when the epidemic was officially designated as a global pandemic the combination of accommodative monetary policy by the Federal Reserve and expenditures by the US treasury has caused the dollar to decline by a little over 14%. Since gold is typically paired against dollars any sharp decline in the dollar will have a negative correlation that will take gold prices sharply higher.

The realization that this pandemic has a way to go before it runs its course is at odds with the true optimism regarding the newly created vaccines which have been tempered by the timeline needed before it is readily available to the public. To achieve herd immunity around 70% of individuals must be vaccinated. Until that occurs, we can expect continued economic contraction, which will be followed by the Federal Reserve and the U.S. Treasury Department continuing to implement policies theg

that will take the U.S. dollar lower. As such we are still under the assumption that gold prices will in fact trade to a new record high by the second quarter of 2021.

Wishing you as always, good trading and good health,