There is one systemic risk parameter that is creeping higher in the background, namely the gold price. We can identify a rising trend in the gold price independent of the other usual suspects among safe-harbor assets (TIPS, Japanese yen, volatility). And we can identify the trend’s starting point in February 2016, coinciding with a spike in Chinese equity market volatility. China risk topped the list of investor concerns early in 2016, and it is not surprising to find the implied volatility of options on the most liquid China H-shares ETF among predictors of the gold price. In the meantime volatility has fallen and the perception of China risk has diminished, but the upward trend in gold remains.

Three possible interpretations of the trend occur to me:

1) Now that comprehensive anti-money-laundering rules are in effect in every offshore banking center, gold may be in greater demand as a store of value and medium of exchange (like cryptocurrencies);

2) The persistence of America’s budget and current-account deficits persuades investors, including some central banks, to increase their allocation to gold. Trump’s tax cut may boost growth in the short or medium term, but the US cannot finance itself at these rates indefinitely;

3) Russia and China and other countries want to increase their independence from the US dollar for political reasons and have increased gold allocation. Russia bought 214 tons of gold in 2017, increasing its total holdings by about 12%, for example.

Gold and TIPS both can be thought of as deep out-of-the-money puts on the US dollar (or out-of-the-money calls on the inflation rate). It is not surprising (and now widely commented) that they trade more or less in tandem (with an r-squared of 77% over the past 11 years):

Source: Bloomberg

Using a breakpoint regression, we see clearly that (after correction for serial correlation) the gold-TIPS relationship showed a positive trend from 2007 to late 2011, a negative trend until early 2015, and a positive trend from early 2015 to the present (See below). Econometric measurement aside, we can see visually that gold moved out of line with TIPS starting in the middle of 2017.

Source: Bloomberg

We obtain a reasonably accurate forecast of the gold price if we add a linear trend variable as well as implied volatility on FXI to the right-hand side of the equation along with TIPS.

Source: Bloomberg

It isn’t surprising that the early 2015 spike in China H-shares volatility coincided with a rise in the gold price, a systemic risk gauge. Since then, volatility has fallen in the Chinese market along with every other market.

The gold price remains out of line and bears close watching. It may represent nothing more than greater demand for assets outside of the purview of law enforcement, or a predilection for non-dollar reserves by Russia and China. Or it might represent a residual perception of risk in the background to buoyant markets.