Things are Breaking

Theme and Background

This chapter focuses on the market performance of gold and major asset classes in September 2022, analyzing the impact of the Federal Reserve's aggressive rate hikes, the surging US dollar, and the sharp rise in real yields on global financial markets. The report specifically highlights how the UK bond market crisis exposed the fragility of the global financial system and explores the investment value of gold in the current macroeconomic environment.

Core Views

The author argues that gold's break below the $1,700 support level to $1,660.61 (down 2.95% monthly and 9.22% annually) signals broad pressure on risk assets, though gold still outperforms most asset classes. The key judgment is that the US Dollar Index (DXY) rose to 112.12, a 20-year high, while the 10-year real yield surged 96 basis points to 1.67%. The simultaneous surge in both is a rare event over the past 25 years, leading to a sharp tightening of financial conditions that will ultimately trigger systemic risk. A contrarian view: despite short-term pressure on gold, the UK crisis shows that central bank policies have no room to retreat, and gold as a safe-haven asset will benefit when systemic risk erupts.

Key Arguments and Data

1. Federal Reserve Policy: Three consecutive 75-basis-point rate hikes brought the rate to 3.25%, with market expectations for a terminal rate of 4.50%-4.75%. Quantitative tightening (QT) accelerated to $60 billion in Treasuries plus $35 billion in MBS per month, totaling $95 billion, far exceeding the 2018 monthly average of $50 billion.

2. US Dollar and Real Yields: The DXY rose 17.19% year-to-date to 112.12, while the 10-year real yield surged from 0.71% to 1.67% (up 96 basis points monthly), marking the largest single-month increase in history. The simultaneous surge in both is the most extreme case in the past 25 years.

3. Asset Performance Comparison:

Asset Class	September Close	August Close	Monthly Change	Monthly % Change	Annual % Change
Gold	$1,660.61	$1,711.04	-$50.43	-2.95%	-9.22%
Silver	$19.03	$17.99	+$1.04	+5.76%	-18.36%
Gold Stocks (GDX)	$24.12	$23.80	+$0.32	+1.34%	-24.70%
S&P 500	3,585.62	3,955.00	-369.38	-9.34%	-24.77%
US Treasury Index	$2,172.70	$2,250.42	-$77.72	-3.45%	-13.09%

4. UK Crisis: Surging UK gilt yields and a plummeting pound triggered margin calls on pension derivatives and leveraged repo positions, leading to a death spiral of forced liquidations. The Bank of England was forced to restart quantitative easing (QE) by purchasing long-term government bonds without limit, though it still planned to continue QT later. The author argues this exposed the failure of Modern Monetary Theory (MMT) in G7 economies.

Companies/Assets Involved

• Gold Bullion: Broke below the $1,700 support level, with the next support around $1,550 (pre-pandemic levels). Still outperforms most assets.
• Silver Bullion: Rose 5.76% monthly to $19.03, showing positive divergence from gold and relatively strong performance.
• Gold Stocks (GDX): Rose 1.34% monthly to $24.12, returning to a long-term support range.
• US Treasuries: The 10-year nominal yield rose to 3.83% (highest since 2008), with real yields at 1.67% (largest single-month increase in history). The Treasury index posted a year-to-date drawdown of -16.6%, three times its typical maximum drawdown.
• Gold ETFs: Holdings fell 2.83% in September to 97.04 million ounces, erasing all gains for 2022.
• Silver ETFs: Holdings fell 1.22% in September to 763.98 million ounces, with annual outflows at a record pace but slowing.

Investment Implications

1. Short Risk Assets: The simultaneous surge in the US dollar and real yields represents the most extreme tightening of financial conditions in 25 years. The S&P 500 has fallen 24.77% year-to-date into a bear market, while bond drawdowns are three times typical levels, with systemic risk accumulating.

2. Long Gold: Gold still outperforms most assets, with $1,550 as a strong support level. The UK crisis proves central bank policies have no room to retreat, and gold will benefit when systemic risk erupts.

3. Monitor UK Crisis Contagion: The failure of MMT in the UK, a G7 reserve currency economy, could trigger a chain reaction in other developed markets. Central banks face a dilemma between fighting inflation and preventing systemic risk, and may ultimately pivot to easing.

4. Watch for Dollar Peak Risk: The surging dollar has already pressured global forex markets, potentially leading to coordinated intervention similar to the Plaza Accord, which would be bullish for gold.

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Theme and Background

This chapter focuses on the anomalous shifts in current market volatility structures, extreme gold positioning, and the high correlation among macro trades. It argues that these signals indicate the market is approaching a critical inflection point for a Federal Reserve policy pivot. The author notes that the UK gilt crisis is a typical example of a "market accident" following liquidity tightening, and a scenario similar to 2018, which forced the Fed to pause QT, may repeat.

Core Thesis

The author's core judgment is: The current volatility sequence has completely reversed historical patterns—bond volatility leads rather than lags equity volatility, reflecting the unique backdrop of the inflation fight. The author believes that equity volatility (VIX) currently lags other asset classes but is poised to "catch up" and surge, potentially triggering market expectations for a Fed pause or pivot. Additionally, gold's positioning structure (CTA shorts near decade highs, ETF "sticky money" still above pre-pandemic levels) creates conditions for a price squeeze rally.

Counterintuitive Judgments:

• Gold volatility (GVZ) is highly correlated with equity volatility (VIX) (R²=0.71) but nearly uncorrelated with bond, currency, and credit volatility—meaning gold's safe-haven behavior is sensitive only to equity panic, not overall financial stress.
• The current high correlation among macro trades (yen, real rates, gold) is "unsustainable," and a reversal would trigger violent volatility.

Key Arguments and Data

1. Volatility Structure Reversal:

• Over the past 40 years: Equity volatility surges → commodity/credit/forex → interest rate volatility rises last (typically signaling central bank rate cuts).
• In 2022: Bond volatility leads, followed by forex and credit, with equity volatility lagging (see Figure 5 for standardized volatility indicators).
• The author argues that equity volatility is "poised" to catch up with other assets.

2. Gold Volatility's Unique Link to Equities:

• The 5-year R² between GVZ and VIX is 0.71, versus 0.15 with MOVE (bond volatility), 0.23 with G7CUR (currency volatility), and 0.27 with CDS (credit volatility) (see Figure 6).
• Gold volatility exhibits positive skewness (volatility rises when gold prices increase), a characteristic of its safe-haven attribute.

3. Extreme Gold Positioning:

• CFTC managed funds (CTA) long positions are at the low end of the 10-year range, while short positions are near the high end of the 10-year range (see Figure 7).
• Non-GLD ETF gold holdings ("sticky money") are approximately 12 million ounces higher than pre-pandemic levels, while GLD and other reported holdings have returned to or near pre-pandemic levels (see Figure 8).
• The author notes that CTA needs to be "extremely short" and "sticky money" needs to capitulate to push gold prices lower, while China, India, and central banks have increased purchases over the summer.

4. High Macro Trade Correlation:

• The yen, US 10-year real yield, and gold (inverted axis) have been highly correlated since March (see Figure 9). This "super-correlated" trade has persisted for months and been profitable, but policy interventions (e.g., UK, Japan) and deteriorating market depth (poor liquidity) suggest reversal risk.

5. Market Stress Signals:

• The UK gilt crisis is a typical example of a "market accident after liquidity withdrawal," similar to 2018 when the Fed abandoned QT due to an equity crash and repo market freeze.
• "Red flags" in the yen, renminbi, euro, sterling, and UK gilts indicate cracks in forex and interest rate markets.

Companies/Assets Involved

Asset/Instrument	Role and Key Data	View
Gold (Spot/Futures)	Price $1,660.61 (down 2.95% in September), GVZ vs VIX R²=0.71	Bullish: Extreme positioning, CTA shorts near decade highs, conditions ripe for a price squeeze
Gold ETFs (GLD vs Non-GLD)	Non-GLD holdings ~12 million oz above pre-pandemic, GLD back to pre-pandemic levels	Bullish: Sticky money (non-GLD) provides a floor
US Dollar Index (DXY)	Rose to 112.12 in September (20-year high)	Bearish: Policy intervention signals emerging (e.g., Japan, UK), super-correlated trade faces reversal
US 10-Year Real Yield	Surged 96 bps to 1.67% in September	Bearish: Highly correlated with yen and gold; reversal would benefit gold
UK Gilts	5-year yield surged (see Figure 4)	Bearish: Crisis highlights QT risks, may force BoE pivot
Yen	Highly correlated with gold and real rates (see Figure 9)	Bearish: Policy intervention (e.g., BoJ) may trigger trade reversal

Investment Implications

• Add to Gold Longs: With CTA shorts extreme, sticky money not capitulating, and central bank/emerging market buyers entering, gold's downside is limited and upside squeeze probability is high. Wait for a VIX surge as a leading signal for a Fed pivot.
• Short Macro Correlation Trades: The current "super-correlated" trade among yen/real rates/gold is overextended. Once policy intervention (e.g., UK, Japan) or a liquidity collapse occurs, this trade will reverse violently, and gold may benefit from a weaker dollar and lower real yields.
• Watch for Equity Volatility Surge: VIX lags other volatility indicators. Its catch-up surge could act as a catalyst for market panic, reactivating gold's safe-haven properties.