By: Rhona O'Connell, Head of Market Analysis
Gold: - new quarter, old arguments; the data trap
After a quarter in which gold was largely in thrall to the interpretation of Fed policy, along with a close eye on ECB and People’s Bank attitudes towards the economic and financial environment, we start the second half of the calendar year trading between $1,775 and $1,780/ounce, which is some 6-1/2% below the level at the start of January. In euro terms it is down 3.7%; in rupees, 4.6% and in yen terms it is in positive ground, up by just 0.8%.
Opinions among market observers are mixed.
There is a view that the prognosis for the dollar is positive and that after the bond market’s rebalancing in the wake of the Fed’s views (please find the most recent piece here looking at the nature of inflationary forces and comparing the situation across regions and the relevant central banks’ policies), the only way for the long end is Up. This would put some pressure on gold prices, especially with the high correlation with the ten-year yield (-0.85 year to date), the argument goes. But the correlation with the two-year yield, at -0.94, is higher than that of the ten-year and the medium-term tenors have all already bounded up in the wake of the recent FOMC meeting and Committee Members’ subsequent public pronouncements, as the yield curve flattened (although some of this has subsequently been unwound, with the 30-year yield now back to where it was a month ago..
U.S. Yield Curve
Source: Bloomberg
It is equally arguable, therefore, that the likely tapering in the Fed’s programme, which may well now start in 2022, is already priced into gold. Certainly, the massive clear-out in mid-June, taking prices from over $1,900 to below $1,770 in a 7.6% drop in the space of a week, swept away a number of weak-handed holders, as well as generating momentum and stop-loss trading; it appears that where was also option-related activity that exacerbated the move.
So where does this leave us now?
The physical market has picked up in many parts of south-east Asia and these is also some sign of interest in the Middle East. India is still in lockdown and the monsoon has started so we could see a massive unleashing of pent-up demand this year, provided of course that the virus has been brought at least under some control. Diwali this year is late, on 4th November, but could well prove to be the pinnacle of a lively post-monsoon season.
Of course the fundamentals are only a part of the market’s matrix, especially as average annual OTC trading is more than 100 times that of annual mine production so shorter-term (and medium-term) moves will be largely a function of financial economic and geopolitical forces. But re-emergence of fresh physical demand can cushion falls and prepare the ground for recovery (and vice versa in times of price spikes).
Gold and the S&P:Gold Ratio
Source: Bloomberg
We would argue that as well as the market already pricing in the shift in the Fed’s position, and in the knowledge that the next FOMC meeting that sets out economic projections is not until 21st-22nd September, all eyes will be on the Jackson Hole economic symposium on 26-28 August, plus any nuances from the 27-28 July FMC meeting. U.S. economic numbers over the next few weeks, particularly employment. U.S. unemployment (currently at 5.8%) is still way too high to single-handedly drive persistent inflationary forces – and at 8% in Europe the position is even milder with respect to a persistent-inflation outlook for the medium term. We are of course seeing a push for higher prices in the short term, and this will accelerate in the next few months as the services sectors, which are a large part of both economies, get back up to speed. But as the 2020 dislocations drop out of the system and bottlenecks gradually become resolved, price pressures should fade to a degree.
To some extent all of this is academic because real interest rates are well below zero virtually globally (except in China, while Russia is already raising rates in an effort to head inflation off at the pass). And while real rates are negative gold has tail winds rather than head winds; there is still a lot of liquidity looking for a home and gold, it must always be remembered, is a hedge against risk, not just inflation. Gold only really kicks in as an inflation hedge when inflation itself is accelerating and/or becoming a threat to economic activity – or when inflationary expectations are building.
This will be the crux of the matter. When and to what extent does inflation cease being transitory and became persistent? We, like Jay Powell, need to wait for more data yet. Next stop: the nonfarm payroll figures tomorrow, called at +700,000 approximately, with unemployment coming down to 5.6%.
Barring any massive outliers over the next few weeks, we may find a number of markets struggling for direction, particularly as we watch the development of the rotation trade and the inflated valuations of parts of the equity markets. Gold could well find itself in the same camp.
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