The Cure to Quantitative Tightening

I don’t look at the currency market for guidance on how stocks are likely to perform. Too often, futures trading in the dollar and other major currencies is based on macroeconomic trends that do not always correlate highly to how stock prices are likely to perform in the near term.

But something unusual has occurred in the currency market over the past month that has caught my attention. Through the first three weeks of April, the price of gold rose 4% while Bitcoin (BTC) fell 13.3%.

Of course, gold is not a currency, at least not in the conventional sense. It is a precious metal that at one time backed the U.S. dollar until 50 years ago. Since then, gold has been viewed as more of an inflation hedge even though its performance as such has been inconsistent.

Normally, I don’t pay much attention to gold, either. Since peaking above $1,900 an ounce in 2011, the price of gold has fallen while the stock market soared.

For that reason, gold has come to be viewed as the province of doomsayers fearful that the end is nigh. When the apocalypse comes, apparently gold will be the only form of payment accepted at your local grocery store.

I don’t agree with that logic, and there is a good reason why gold is strengthening. Since the onset of the coronavirus pandemic 15 months ago, the United States Money Supply has increased by nearly 60%.

To be sure, central bankers around the world did not have much choice. Since COVID-19 all but brought the world to a halt, the global economy has been skating on very thin ice.

An Ounce of Prevention

Some of that money will be reclaimed by the Fed as it sells bonds out of its massive portfolio. At the start of this year, the U.S. Federal Reserve held more than $7 trillion of various forms of debt on its balance sheet.

The problem is that by deleveraging its balance sheet, the Fed will be adding supply into an already crowded bond market. Over the past six months, the yield on the 10-year Treasury note has more than doubled. And that was while the Fed was a net buyer of bonds.

Once the Fed becomes a net seller of bonds, it is likely that interest rates will rise even higher. And since gold is traded in dollars around the world, its price will most likely go up, too.

I have been watching gold mining stocks for confirmation that the gold rush is on. Sure enough, the financial hawks on Wall Street were one step ahead of the currency traders.

On March 1, Canadian miner Barrick Gold (NYSE: GOLD) bottomed out below $19. Over the next seven weeks, it rallied above $22. Since late January, U.S. miner Freeport-McMoRan (NYSE: FCX) has gained more than 50%.

While the rest of the world has been distracted by YOLO (“you only live once”) stocks and SPAC (special purpose acquisition company) deals, the money pros have been buying up gold. Apparently, they think they know something that the rest of us don’t.

In this case, it appears they believe investors will abandon trendy cryptocurrencies in favor of gold when interest rates take off and the dollar tanks. If they turn out to be correct, it’s not too late to get in the game.

A Pound of Cure

The SPDR Gold Shares (GLD) ETF owns notes that are fully collateralized by physical gold. For that reason, its share price moves in lockstep with the price of gold.

Of course, you could buy shares of GLD as a portfolio hedge against devaluation of the U.S. dollar. In that case, what you lose in stocks and bonds should be made up for by what you gain in gold. Last month, I explained how you can use GLD to generate income by selling call options against your position in it.

But if you really want to capitalize on future devaluation of the dollar, consider buying a call option on GLD instead. A call option increases in value when the price of the underlying security goes up.

Last week while GLD was trading near $167, the call option that expires in January 2023 at the $165 strike price could be bought for $15. For that trade to be profitable, GLD would only need to appreciate by 9% over the next 20 months.

The argument against doing this trade is that GLD has already appreciated nearly 40% over the past two years. But as we have witnessed with Bitcoin, up more than 600% during the past year, there is no top-stop when investors panic.

Editor’s Note: Our colleague Jim Pearce just provided you with invaluable investing insights. But his article only scratches the surface of our expertise. You also should consider Robert Rapier, chief investment strategist of Rapier’s Income Accelerator.

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