Gold, Steady in its Purpose

Theme and Background

This chapter analyzes the market performance of precious metals and major asset classes in May 2022. The report notes that against the backdrop of the Federal Reserve's hawkish stance, deteriorating liquidity, and slowing economic growth, almost all asset classes experienced deleveraging-driven sell-offs, but the market has not yet seen a panic crash.

Core Views

The author believes that gold outperformed most asset classes in May but failed to rally significantly due to safe-haven demand, as the market is in a "deleveraging" rather than a "crisis" mode. The report emphasizes that gold and cryptocurrencies serve opposite functions: gold is a safe store of value, while cryptocurrencies are speculative trading tools. A counterintuitive judgment is that despite market depth approaching the lows of March 2020, gold did not see panic buying but instead moved in tandem with the broader market.

Key Arguments and Data

• Gold Performance: Spot gold closed May down 3.14% at $1,837.35 per ounce, up only 0.45% year-to-date, but outperforming the S&P 500 (down 13.30% YTD) and the Nasdaq 100 (down 22.54% YTD).
• Market Depth: The market depth indicator constructed by the report (including equity index futures, government bonds, credit, and currency liquidity) has approached the lows of March 2020, which previously forced central banks to inject massive liquidity. When market depth deteriorates, gold typically outperforms equities (the S&P 500/gold price ratio declines).
• Comparative Data:

Asset	YTD Return	Correlation with S&P 500	YTD Realized Volatility
Spot Gold	0.38%	-0.18	10.55
Spot Silver	-7.50%	-0.13	18.92
S&P 500 Index	-13.30%	1.00	30.60
Nasdaq 100	-22.54%	0.98	40.46
Bitcoin	-31.38%	0.56	40.07
ARK Innovation ETF	-53.39%	0.81	78.91
Bloomberg Commodity Index	32.44%	-0.03	19.13

• Liquidity Deterioration: The market depth indicator in May approached the lows of March 2020, but metrics such as volatility and credit default swaps, while elevated, did not "spike," indicating no direct threat to the financial system. The report warns that the market remains vulnerable to panic if "something breaks."
• Commodities: Brent crude closed at $122.84 per barrel, only 4% below the February price peak of $127.98; U.S. natural gas prices hit a 14-year high; the Bloomberg Grains Index has surpassed its February high, as multiple countries announced export bans and Ukrainian ports remain closed.

Companies/Assets Involved

• Gold Bullion: Bullish. YTD return of 0.38%, negative correlation with the S&P 500 (-0.18), lowest volatility (10.55), making it an effective diversification tool in a portfolio.
• Gold Mining Stocks (SOLGMCFT Index, GDX): Neutral to bullish. Down 8.63% in May but still up 2.33% YTD, testing and holding key support levels.
• Silver Bullion: Neutral. Down 7.54% YTD, rebounding from channel support.
• Bitcoin: Bearish. Down 31.38% YTD, with a 0.56 correlation to the S&P 500 and volatility of 40.07. The report characterizes it as a speculative trading tool, opposite in function to gold.
• ARK Innovation ETF: Strongly bearish. Down 53.39% YTD with volatility of 78.91, a typical representation of the collapse in risk appetite.
• S&P 500 Index: Bearish. Down 13.30% YTD, approaching a 20% drawdown (bear market definition) in mid-May, weighed down by retailer earnings warnings and inflationary pressures.

Investment Implications

• Gold as a Portfolio Hedge: In an environment of deteriorating liquidity and deleveraging, gold's low volatility and negative correlation make it an effective risk-diversifying asset. Investors should increase gold allocations rather than reduce them during sell-offs.
• Beware of Market Depth Risk: Current market depth is near March 2020 levels. If a "black swan" event occurs, it could trigger panic selling. Gold may rally significantly in a crisis, but investors must endure volatility beforehand.
• Avoid High-Correlation Speculative Assets: Assets like Bitcoin and ARK are highly correlated with equities and exhibit extreme volatility, posing high risks during deleveraging cycles. The report suggests that the divergence between gold and cryptocurrencies will intensify.

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Theme and Background

This chapter focuses on the liquidity shock from the Federal Reserve's quantitative tightening (QT) launch and the uncertainty surrounding peak inflation signals. The report notes that QT will begin on June 1, with an initial monthly reduction of $47.5 billion ($30 billion in Treasuries + $17.5 billion in mortgage-backed securities), rising to $95 billion per month after September. The author argues that QT's impact on market depth, volatility, and fragility is underestimated, which could instead support gold.

Core Views

• QT's negative impact is underestimated: QE was used to lower borrowing costs and stimulate spending; QT will have the opposite effect, exacerbating market depth deterioration, rising volatility, and dysfunction.
• Fighting the Fed is futile: The Fed is explicitly pursuing the destruction of demand through negative wealth effects, with its toolkit having fully shifted from low rates, dovish guidance, QE, and low volatility to high rates, hawkish stance, QT, and high volatility.
• Earnings recession is not yet priced in: While the probability of an economic recession is uncertain, the likelihood of an earnings recession is higher. In the past four recessions, earnings fell by an average of about 20% from peak to trough.
• Three "market puts" have expired: The Fed put, the retail dip-buying put, and the bond-stock negative correlation put have all disappeared or shifted significantly lower.
• Cryptocurrencies have not proven their safe-haven properties: Bitcoin has experienced four major drawdowns since 2011, with the current drawdown around 50% and a 30-day realized volatility averaging about 60% (compared to 21% for the Nasdaq).

Key Arguments and Data

1. QT Scale and Impact:

• The first three months will see a monthly reduction of $47.5 billion ($30 billion in Treasuries + $17.5 billion in MBS), rising to $95 billion after September.
• The author believes QT will reduce market depth, increase volatility, and heighten fragility—factors that have historically supported gold.

2. Historical Comparison of Earnings Recessions:

• In the past four recessions, earnings fell by an average of 20% (peak to trough).
• The 2022 market sell-off has primarily been driven by valuation compression (derating) and has not yet been earnings-driven, as earnings are still rising.

3. Sources of Inflationary Pressure:

• Energy supply and inventories are too low, and sanctions on Russia could worsen the situation.
• Russia is one of the largest exporters of oil and natural gas, while Ukraine is a major exporter of wheat and fertilizers; the correlation between food and energy prices is at an all-time high.
• The labor market is in its "tightest state in generations," with wage spiral effects emerging.
• The housing market remains a seller's market: record-high home prices, low inventory, and building permit numbers.

4. Cryptocurrency Performance:

• Cryptocurrency market capitalization has fallen from a peak of about $3 trillion to $1.31 trillion, a loss of approximately $1.7 trillion (-56%).
• Bitcoin's 30-day realized volatility averages about 60% (compared to 21% for the Nasdaq).
• Bitcoin has historically experienced three drawdowns of around 80%; the current drawdown is about 50%.

5. Market Sell-off Characteristics:

• The sell-off is "rolling," starting with growth stocks, high-P/E stocks, large-cap tech, and speculative sectors, then gradually expanding to all sectors.
• The May lows lacked true capitulation and panic; a final surrender may not occur until the Fed pivots dovish, but such a pivot would require a major systemic stress event (e.g., employment risks).

Companies/Assets Involved

Asset/Company	Role and Key Data	View
Gold	Benefits from QT-induced liquidity deterioration and market fragility	Bullish (as a safe-haven asset)
Bitcoin/Cryptocurrency	Market cap fell from $3 trillion to $1.31 trillion (-56%); 30-day volatility 60%	Bearish (speculative nature, unproven safe-haven function)
S&P 500 Index	Down 13.30% year-to-date (May data)	Bearish (earnings recession not priced in)
U.S. Treasury Bond Index	Down 8.33% year-to-date (May data)	Bearish (rising yields)
Energy/Grain-Related Assets	Supply shortages due to Russia-Ukraine conflict, prices continue to rise	Bullish (inflation-driven)

Investment Implications

• Maintain gold safe-haven positions: The launch of QT will exacerbate market depth deterioration and volatility, potentially benefiting gold as a safe-haven asset. A Fed dovish pivot would require a major crisis event; maintain defensive positioning until then.
• Beware of earnings recession risk: Current valuation compression has not yet reflected earnings declines. If an earnings recession occurs, P/E ratios will be further revised downward. Avoid high-P/E, long-duration assets (e.g., growth stocks, large-cap tech).
• Stay away from cryptocurrency speculation: Cryptocurrencies have not proven their function as a store of value or hedge; high volatility and strong correlation with risk assets make them unsuitable for safe-haven allocation.
• Focus on inflation-driven assets: Energy, grains, and fertilizers continue to rise in price due to supply shortages and geopolitical risks; related commodities and stocks may benefit.