The current downturn in the global liquidity cycle isn't primarily due to central bank tightening. Instead, a robust real economy is "crowding out" financial markets by pulling capital away, creating an inverse relationship between the two cycles.
China is expanding its domestic money supply to devalue internal debt. With crypto banned, gold is the primary hedge for Chinese citizens against this devaluation, making People's Bank of China (PBOC) liquidity a key driver of the global gold price.
Western markets like COMEX are no longer the primary price setters for gold. Asian demand, centered on the Shanghai Gold Exchange, is now the marginal driver. Investors should therefore analyze the gold price in Chinese Yuan for more accurate signals.
Contrary to textbook economics, the market controls interest rates. Rising long-term bond yields, driven by strong nominal GDP growth, are forcing the Federal Reserve to follow with higher policy rates, rather than the Fed leading the market.
The gold-oil ratio reliably tracks the 5-6 year liquidity cycle. In an upswing, liquidity fuels gold, raising the ratio. In a downswing, a strong real economy boosts oil demand, causing the ratio to fall and mean-revert. This framework predicts which asset will outperform.
Central bank actions only initiate the liquidity cycle. The cycle becomes self-perpetuating as initial liquidity pushes up asset prices, increasing collateral values. This enables more borrowing and creates more liquidity in a feedback loop outside of central bank control.
The yield on the two-year Treasury note has historically been correct 85% of the time in predicting future Federal Reserve policy rate changes. This makes it a more reliable forward indicator than analyst commentary or official Fed guidance.
Global liquidity drives a predictable asset allocation regime. We have exited the 'Calm' phase (broad equity gains) and entered 'Speculation,' marked by high volatility and poor quality returns. The next phase, 'Turbulence,' requires defensive positioning.
Crypto prices are highly sensitive to global liquidity, particularly from the US Federal Reserve. In contrast, gold's recent performance is primarily a hedge against the People's Bank of China's internal liquidity expansion, explaining the assets' recent divergence.