The expanding BRICS bloc is moving away from the PetroDollar, looking to settle oil imports in their domestic currencies. But that is unlikely to be achieved without the use of an alternative reserve asset that can be used to settle trade imbalances. The only likely candidate is Gold.
But first let’s start with a review of financial markets.
Financial Markets
The Chicago Fed Financial Conditions Index fell to -0.53, signaling further monetary easing.
Bitcoin found support above $60K and recovery above $68K would signal a re-test of resistance at $72K, indicating ample liquidity in financial markets.
10-Year Treasury yields respected resistance at 4.35%. Breach of support at 4.20% would signal another test of 4.05%.
Janet Yellen at Treasury is doing her best to keep a lid on long-term Treasury yields in order to ensure a smooth run-up to the November elections. This includes limiting the supply of long-term Treasuries by issuing short-term T-Bills in their place.
Keeping long-term yields low helps to support stock prices. High stock prices in turn boost tax revenues which reduce the deficit and new issuance of USTs.
The S&P 500 weekly chart shows how the index has been rising since late-2023. Shallow corrections, of less than 3%, indicate exceptional buying pressure. That and a strong rise in the Trend Index (above zero) suggest that stocks are getting overheated.
The magnificent 7 technology stocks have been leading the advance but now two — Apple (AAPL) and Tesla (TSLA) — are falling behind. A stumble in more key stocks would be cause for concern.
The Dollar
The Dollar Index, shown on the weekly chart below, is headed for a test of resistance at 105. Breakout would signal an advance to 107. The sharp rise on Friday is attributed to a surprise rate cut by the Swiss central bank.
The PBOC also relaxed its managed float, allowing the exchange rate to rise above 7.2 Yuan to the Dollar.
It is unusual to see the Dollar strengthening while long-term Treasury yields are falling. We need to monitor this closely.
Crude Oil
Brent crude is retracing to test support at $84 per barrel. But respect is likely and would confirm our target of $94 per barrel. If that occurs, we expect upward pressure on inflation in the months ahead.
Gold
Spot Gold in London is retracing to again test support at $2150 per ounce. Respect would signal another advance and follow-through above $2200 would confirm our target of $2400.
A New Paradigm
The global crude oil market dwarfs other commodities, with production of more than 100 million barrels per day (EIA). Gold production is only 5000 metric tonnes per year — a fraction of the crude market — but the two have close historic links.
High crude prices often coincided with high gold prices. It was believed that oil producers increased purchases of gold when they made excess profits but in the last decade, there has been greater divergence between Gold and Crude.
Another historic factor was the relationship between gold and real interest rates. The chart below shows how gold made large 12-month gains (orange) whenever the real 10-year Treasury yield (adjusted for CPI) fell below zero.
Negative real yields were the perfect signal to go long Gold, in expectation of rising inflation, funded by negative real interest rates. But that relationship too broke down, with negative real yields of -5.0% accompanied by falling Gold prices after August 2020.
Gold bulls have long accused the Fed/Treasury of manipulating the gold price. In the 1960s, it was done openly by the London Gold Pool, a consortium of 8 major central banks, led by the Fed, who collaborated to maintain a fixed gold price of $35 per ounce. The Gold Pool collapsed in 1968, allowing gold to appreciate above the fixed exchange rate. This led to Richard Nixon to end US Dollar convertibility to gold in 1971.
It makes sense for central banks to suppress the price of Gold — this would increase demand for US Treasuries and other sovereign debt as reserve assets.
We have also observed unusual activity on Comex futures, with heavy selling into rallies. Any rational seller would sell in smaller quantities and avoid off-peak times — when bids are thin — in order not to interrupt the trend and maximize prices achieved. Large sellers generally take pains to avoid alerting the market as to their intentions. The opposite of some of the “shock and awe” selling in futures markets that we suspect is intended to destroy momentum built up in preceding days.
Typical Gold Dump in Futures Market, February 2nd 12:36 PM to 12:45 PM
These are merely suspicions. We have no definitive proof. But those suspicions are now being put to the test.
BRICS+
China and Russia have been uncomfortable with US dominance of the global financial system and have long been making efforts to establish an independent reserve currency as an alternative to the Dollar. Their efforts failed to gain much traction until Russia’s full-scale invasion of Ukraine in 2022. US and European sanctions — blocking Russian assets held by European banks and removing Russian banks from the SWIFT payments system — alerted non-aligned countries to their vulnerability should they ever offend the US or its European allies.
The response has been an expansion of the BRICS bloc, with Iran, Saudi Arabia, the United Arab Emirates, Argentina, Egypt and Ethiopia invited to join in August 2023. Argentina has since declined the invitation — after the election of Javier Millei — and the Saudis are “still considering”. The shift is motivated by a desire to reduce dependence on the US Dollar for trade — and US Treasuries as a reserve asset.
Central bank (CB) gold purchases are growing.
Jan Nieuwenhuijs recently suggested that CB purchases may be far higher than official declarations (red below). He estimates that 80% of unreported purchases are made indirectly on behalf of CBs.
PBOC purchases account for a large percentage of unofficial buying.
Crude Oil Payments
Major oil importers like India and China have signed agreements to pay for oil in their own currencies but that is likely to leave exporters like Russia and the Saudis holding excess Rupees and Yuan that they do not need and are unlikely to want to hold as reserves.
Non-USD trade in oil would only be viable if net trade imbalances are settled by transfer of gold between trading partners, with surplus countries like the Saudis purchasing gold from the Chinese with Yuan that are surplus to their needs. Demand for gold is expected to rise exponentially as the BRICS bloc expands and oil trades are increasingly settled in domestic currencies. Major oil importers like India and China are likely to require larger gold holdings in order to settle trade imbalances with oil exporters like the Saudis and Russians. Oil exporters are expected to recycle gold to fund purchases of goods and services from non-BRICS trading partners but the total “float” of gold in the system is likely to increase.
We continue to see a growing pile of evidence that gold is re-becoming an oil currency, which by virtue of the oil market alone being some 12-15x the size of the global physical gold market annually, suggests a continued relentless bid for gold in coming quarters and years that will puzzle many on Wall Street. ~ Luke Gromen
Physical Gold Flows
Physical gold is flowing out of London and Zurich as Asian buyers bid up prices.
A recent Doomberg interview pointed out that Gold quoted on the Shanghai Gold Exchange is at a premium of between $20 and $40 per ounce above the London Gold price. Friday’s PM Benchmark of CNY 511.40 per gram converts to $2200 per troy ounce, compared to the London spot price of $2165 per ounce — a premium of $35.
Arbitrage will ensure a steady flow of physical gold out of London and Zurich for as long as that premium is maintained.
Gold in CNY/gram as quoted on Shanghai Gold Exchange
(red = AM, blue = PM benchmark price).
Conclusion
Stocks continue their bull run, supported by strong liquidity in financial markets and weakening long-term Treasury yields.
The Dollar has diverged, however, rising sharply against the Euro and China’s Yuan. Dollar Index breakout above 105 would warn of an up-trend with an immediate target of 107.
Gold is retracing to test support at $2150 per ounce. Respect would signal another advance. But we need to be careful of the rising Dollar. Breakout above 105 would be likely to weaken demand for Gold.
Brent crude is testing support at $84 per barrel. Respect is likely and would confirm our target of $94. High crude oil prices would be expected to increase inflationary pressures in the months ahead and force the Fed to delay rate cuts. The resultant rise in long-term Treasury yields would be bearish for stocks.
We expect a new paradigm to emerge, where the Gold price is no longer determined by Western buyers seeking an inflation hedge to protect against erosion of currency purchasing power and as a safe haven when risk is high. Marginal buyers are likely to be BRICS+ (the expanded BRICS bloc) central banks, seeking to use gold to settle trade imbalances from oil and gas imports paid for in non-USD currencies. The supply of Gold is inelastic, so the price is expected to rise steeply until a new equilibrium is reached.
Acknowledgements
Treasury debt held by the public is projected to rise to a precarious 160% of GDP by 2050.