GLD: The Dollar Implodes (Again), Don’t Let Your Portfolio Erode (NYSEARCA:GLD)

Thesis Summary

Gold (NYSEARCA:GLD) started the year off with a bang, but has since cooled off in the last few weeks. I view this as a great long-term opportunity to buy gold, which is now more important than ever given the global trends in inflation and the dollar.

The Secular Decline of The Dollar

The dollar has held a privileged position in the world’s monetary system for the last 100 years, but this is slowly, but surely, coming to an end.

Back in the 1970s, the dollar lost its peg to gold. This caused some turmoil in the coming decade, with commodity prices skyrocketing, and inflation persisting throughout the 70s.

But still, the dollar managed to remain atop the fiat currency food chain. This is because the US economy commanded a lot more value than all the other major economies. Europe was coming out of a devastating war, and the BRICs were still developing. The dollar stabilized, thanks in great part to the establishment of the petrodollar, gold stopped shining, and the world began to happily accumulate dollars.

That is, until recently. Over the last 20 years we have seen a clear change in this dynamic. First off, countries are not accumulating dollars at the same pace as before.

According to the IMF, dollars as a percentage of foreign reserves have hit a 25 year low. Countries are no longer hoarding dollars, and this is to be expected given the current trend in de-globalization and most importantly, the growing animosity between China and the US.

Conversely, while dollar holdings are at a low, gold hoarding is at high.

Central banks closed out 2022 with reported net purchases of 28 tons of gold in December. Including large unreported purchases, this brought total central bank gold buying in 2022 to 1,136 tons. It was the second-highest level of net purchases on record dating back to 1950, and the 13th straight year of net central bank gold purchases.

Source: schiffgold.com

You may think the world is changing, but in fact, history is repeating itself.

Gold Will Shine Yet Again

When the dollar de-pegged from gold in 1973, it took the world for a spin. Though there were other reasons, abandoning the gold standard can be directly linked to a weakening dollar, and a period of inflations and recessions.

In the chart below we can see yoy CPI, the Dollar index (DXY) and Interest rates. The shaded areas are recessions.

As we can see, the abandonment of the gold standard was followed by a huge spike in inflation, which wasn’t resolved until 1981, when Paul Volcker took interest rates to 13%.

We can see that the dollar index weakened significantly too. Bear in mind, this compares the dollar to other currencies, and doesn’t show just how much the dollar weakened vis-a-vis gold and oil, which could be seen as truer standards of value.

We can see this in the chart below.

Here we have returns for gold, oil (USO), the SPX (SPX) and the DXY. Commodities were the big winners of this decade. Other big winners of this decade were international stocks.

The MSCI EAFE outperformed its US equivalent from 1970 to around 1985.

In my opinion, what we saw in the 1970s is very similar to what is happening now. The USD system is falling apart. Back in the 70s, it fell apart because the gold standard was abandoned. However, given there was no real alternative, the system stabilized with the help of the Federal Reserve and the petrodollar.

Once again, though, the USD system is falling apart. Countries are going their own way; buying oil with their own currencies, establishing bilateral trade agreements that neglect the dollar as a form of settlement, and even outright competing for the spot of world reserve currency.

Technical Analysis

The fundamentals are quite clear. Less global demand for dollars should lead to a lower price, while higher global demand for gold should lead to a higher price. Arguably, the Federal Reserve could defend the dollar’s value raising rates even further, but this would wreak havoc on the economy, not to mention that at anywhere near 10% interest rates, the government’s debt burden would be unsustainable.

Technical analysis can also be used to support our thesis.

Since the dollar’s peak in 1982, we have been trading inside a downward channel, forming an impulsive wave structure. The recent rally was a top in wave II, which sets us up now for a multiyear bear rally in wave III.

Gold, on the other hand, has a bullish outlook:

I see gold as having put a bottom in wave 4, which would set us up for a multiyear bull rally in wave 5.

We are currently completing a 1-2 setup off the lows. I think we could head lower into $166, finding support at the 200 day MA, but the current price is still attractive long-term.

Given both the larger and smaller degree fib extensions, I see GLD heading at least towards $230.

Final Thoughts

The stage is set for the next decade. I see a weak dollar, strong commodities and higher value in international stocks. At the very least, investors would do well to diversify their portfolios. No matter how many investments you have, you are not diversified if you only hold USD assets.