Gold's Big 'Welcome Home' Hug
Friday, 9/06/2024 13:38
Great news gold bugs! The 'pet rock' returns...
WHAT a summer!
writes Adrian Ash at BullionVault in notes first shared with BullionVault users reading Monday's Weekly Update
email.
Japan raised rates above zero, riots hit England, Ukraine took the war to Russia, one would-be US president promised price controls, another dodged a bullet...
...France went far right then far left, Germany went both ways at once, the UK got a new government with just 1-in-3 votes...
...the Fed vowed to start cutting US interest rates, the Middle East delayed (but didn't defuse) all-out war between Israel and Iran...
...and inflation slowed a bit further from its post-Covid surge worldwide while chip giant Nvidia's earnings beat everyone's expectations but not as much as everyone expected.
Financial impact?
A brief
stock-market slump (and a crash in Tokyo) followed by new all-time highs in developed-world equities as traders bet yet again (only harder) that the US Fed will slash the cost of borrowing Dollars, starting 2 weeks from now.
Oh, and so the inverted yield curve on US Treasury bonds...
...which had been
screaming "Recession coming!" for a record stretch by putting 2-year rates above 10-year rates...
...finally got back to zero and
said that its warning is over.
Gulp! It's the steepening which hurts, remember. Most of all the jobless rate.
"Gold tends to do well in absolute and relative terms during US recessions,"
found a study by James Luke at UK fund managers Schroders in January 2023, noting 19 months ago that "financial markets have been [already] anticipating a US recession for some time" thanks to a "clear signal" from the inverted US yield curve.
"Gold has been excellent at offsetting stock losses during recessions,"
agreed a separate study from Ronald-Peter Stoeferle of Liechtenstein-based wealth managers Incrementum in May 2019, claiming 6 months before anyone got a Covid cough that "recession risks [were already] significantly higher than discounted by the market."
"Gold prices can act as an indicator of the health of the economy," said
a 'Beyond the Numbers' article from the US government's Bureau of Labor Statistics in February 2013...
...eve of gold's steepest price crash in 3 decades.
"A rise in the price of gold may be a signal that the economy is struggling. As a result, in times of either a crisis or inflation, many investors turn to gold to protect their principal."
Whether we now face recession or not, gold at a glance says things really look bad. Stocks in contrast say the opposite. They can't both be right, not unless the whole things has just become about when and how deep the US Federal Reserve will slash the cost of borrowing.
But while it's been a violent, doom-laden and cynical summer in the wider financial and geopolitical headlines, at least gold analysts, traders and investors are seeing things start to normalize.
- Bullion prices set fresh all-time highs as US interest-rate expectations fell with the Dollar;
- Western gold ETFs and speculative betting finally rose together with prices;
- Asia's giant consumer markets in contrast turned cautious, edging prices in both China and India back to a discount versus the global gold price's new records.
After the broken correlations of 2024's first half, all this flips gold's recent patterns on their head as summer ends and the nights draw in. Because the market has reverted to the long-time connections which you could set your watch by...
...and it's reverted just
as everyone says "
China now rules!" rather than Western investment flows.
Hell, we've
even got financial journalists snickering about
'Gold is just a pet rock' again!
"Gold is only worth what it's worth because people think it's worth that much,"
declares one podcaster at the
Financial Times.
Such disdain, it's like a welcome home hug! Bringing biscuits and tea in your favourite mug, let's start with real rates.
Because gold pays no yield but is widely viewed as inflation proof, its price typically shows a strongly negative relationship with the direction of real interest rates.
To track this, analysts and traders tend to look at the yield offered by 10-year US inflation-protected Treasury bonds. And its correlation with gold…
…after defying the laws of nature and showing the most positive connection in almost 2 decades this spring…
…is now back into deeply negative territory, meaning that gold prices have been going in the opposite direction to real rates once more…
(...or going in the same direction if you flip the gold price axis upside-down like our chart does above, hopefully to show the connection more clearly).
To repeat: This return to opposite paths comes after gold's link with TIPS yields upended the usual pattern. It had already skipped a beat when Russia invaded Ukraine in 2022 and inflation rose to 4-decade highs. Gold prices rose and then held firm even as real interest rates shot higher in anticipation of the US Fed (and other central banks) trying to tackle inflation by finally raising the cost of borrowing faster than the cost of living.
Earlier this year, the underlying link snapped again, only more so, with the 1-month average of the 1-month r-correlation coefficient nearing its most positive since gold's price surge of spring 2006, rising even as the real cost of borrowing and the real returns to cash and bonds went higher.
We looked when it mattered at
why this TIPS-gold correlation broke down. So here in autumn 2024, why normalize now?
Well, like the TIPS-gold correlation, Western investing flows have also returned to gold after going absent without leave for most of the past 3 years.
Gold's big surges of late-2023 and spring 2024 came even as Western investment flows went negative, defying
another long-standing basic of how the gold market works.
But these latest highs above $2500...? The giant GLD trust fund loved it. Hot-money betting on Comex futures and options loved it more.
Take note: Coin and small-bar sales remain dire in Europe and North America. Profit-taking has also continued in securely-stored gold owned outright...
...but at a very moderate pace given where prices are trading. And new account openings on BullionVault jumped by 45% in August from the previous 12-month average...
...showing that there's strong pent-up Western investor demand ready to seize on pullbacks in the price of physical gold if not wanting to join the bull market at new higher prices.
More broadly, and as a proxy for wealth management flows, analysts and traders wanting to gauge the size of Western gold investing usually add the size of gold-backed ETF trust funds to the level of bullish betting by speculative traders in US futures and options contracts.
Long term, those 2 added together show a statistically strong correlation against the gold price...
...a 12-month r-squared of 66.9% no less.
It would read 100% if they moved absolutely in lock-step. It sank to a historic low of 0.1% in February this year, but it has now rebounded to a statistically significant 58.9%. And within the trust fund segment,
gold ETF inflows have flipped away from Asia-listed products...
...where investors have suddenly become net sellers as a group...
...back to Western markets, where demand has been positive in 10 of the past 13 weeks, led by the US, UK and France.
Asia's gold consumer demand has also reverted to type this summer, taking fright at gold's new record-high prices after driving it up to a big run of new highs in the first-half of 2024.
Household and investor demand in China has sunk in the face of the precious metal's latest gains, most especially for jewellery. This means Shanghai prices have now been trading below London quotes for 2 weeks running, the longest stretch of discounts since summer 2021.
Gold prices in No.2 consumer India have also gone back to a discount versus global quotes after briefly turning positive in July. Again that suggests softer demand, but
July's surprise (and large) cut to India's gold import duty in the BJP's post-election budget is likely to boost wedding and Diwali festival demand this autumn.
Dealers, retailers and shareholders in India's big listed jewellery firms agree that, even at record high prices...and even with the Rupee near record lows on the FX market...gold will find eager buyers in the world's fastest-growing major economy now that the Modi government has halved total tax costs for gold consumers from 18% to 9%.
Finally, central banks. Like China's private-sector demand in the 12 months to June, official reserves managers as a group broke with their typically price-sensitive behaviour in the past few years...buying more gold even as prices rose to new all-time highs.
Led by China and other emerging-market nations, this demand helped support and boost prices even as Western investment went AWOL. But while the Reserve Bank of India has continued to accumulate bullion, China has reported no additions since April, snapping what had become an 18-month programme of buying at any price. At the same time, official data show Mexico, Kazakhstan and most dramatically Singapore and Turkey taking profit, leading to the first net selling in more than 12 months in June.
So the outlook for gold investment now?
First, the return of regular service...like the end of the inverted US yield curve...remains young and uncertain so far, and it could prove brief.
The previous break in what drives gold higher might yet return and become the new normal, making China the key driver for gold prices rather than US and European flows.
Second, however, extreme correlations tend to reverse in time. (I mean, just look at
gold's current correlation with the stock market. Then look at what history says happens next.) So whether or not the old laws of nature are broken, there will be periods when rising rates hurt gold (or vice versa) and Western investment flows drive prices.
Third, and most urgently, the return of those Western gold investment flows has become dramatic, thanks almost entirely to hot-money betting in the derivatives market. The net long position of 'Managed Money' traders, when added to the size of gold ETFs worldwide, has expanded in size by 16% from 6 months ago; the price of bullion has gained over 22%. But those bullish bets on Comex gold contracts by themselves have more than tripled in size, and that hot money is also running far ahead of the gains in gold over the 3-month and 1-month horizons too.
Yes, the US Fed is
now nailed-on to start cutting interest rates at its September meeting in 2 weeks' time. Weaker competition for savings and investment Dollars from cash-in-the-bank will support further inflows to bullion.
Lower interest rates should also encourage fresh betting on gold in the derivatives market by reducing the cost of betting against the Dollar. But with Comex bulls so far leading the charge in the return of Western investors to gold, there's limited scope for that trend to accelerate as interest rates fall, at least initially. There's plenty of scope, in contrast, for volatility and a price pullback in the meantime...
...not least around this week's ISM manufacturing survey, Thursday's services-sector report from the USA, plus Thursday and then Friday's US jobs data, and then next week's US consumer price inflation data.
Beyond that, and after the Fed starts cutting rates this month, come's November's US election. Trump or Harris, it won't ease tensions with China nor over Ukraine or the Middle East. It's guaranteed to be inflationary too, thanks to higher budget deficits and trade tariffs.
Against the backdrop of Washington's ever-growing debt mountain, that will support de-dollarization and gold-buying by central banks...
...albeit with more dynamic trading, perhaps, if prices spike amid post-election volatility in the currency markets...
...plus continued demand from wealth and fund managers worldwide, most especially in the USA as the Fed cuts monetary policy rates to try avoiding recession while fiscal policy pushes inflation to rebound.
Does this mean fresh gains in gold are guaranteed? No, of course not. Especially not with silver prices failing to follow so far.
The switch from Asian back to Western investment in gold has seen 2024's price jump in its more industrially-useful cousin stall and slip since June. So while gold-mining shares have at last turned higher on the stock market...
...finally rising as you would guess they should during a long-term bull run in gold itself...
...the lack of fresh gains in silver means that gold's big homecoming party isn't missing an important guest, because a key connection which analysts, traders and investors would expect stopped working this summer.
What's more, further gains in gold might prove elusive over the next few weeks thanks to the speed and size of that sudden speculative betting on Comex derivatives.
Indeed, the scale of the hot money's pile-on is waving a "red flag" for a possible price drop reckons Canadian stock brokerage TDS's commodity strategist Daniel Ghali:
"This set-up is the antithesis to the early-2024 dichotomy in [Western gold market] positioning that helped to propel the price on its trajectory towards current all-time highs. Downside risks are now more potent.
"The ship is crowded. In fact, it has scarcely been as crowded as it is today."
But longer term? Given lower rates and rising recession risks?
Maybe gold is just
gonna need a bigger boat.
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