What catalysts can lift the price of gold?
Yvan Berthoux - 29 May 2019
The resurgence of global economic and political uncertainty, following the spike in financial volatility in February 2018, contributed to positive momentum in gold prices in all the major currencies from late last summer. However, the precious metal has been moving sideways since the beginning of the year despite the significant fall in real yields and strong demand from central banks globally. What will it take to send gold prices meaningfully higher?
Numerous empirical studies have demonstrated that gold moves sympathetically with a variety of financial variables such as real interest rates, the US Dollar, stock prices and central bank reserve policies. It is also regarded as a safe-haven asset against periods of elevated political uncertainty or extreme negative financial market shocks. Hence, the higher volatility regime in 2018 revived investors’ motivation to increase their allocation towards precious metals. After an impressive rally in the second half of last year against all the major currencies (figure 1, left frame), gold prices have remained steady in the past few months despite the significant divergence between the price and fundamental volatility (figure 1, right frame).
Data source: Eikon Reuters, Baker et al. (2016)
As expected, gold prices held up well in the fourth quarter of last year: the precious metal was up US$100 while US equity prices fell 20 percent from peak to trough during that period. The 10-year US Treasury yield also dropped in that risk-off environment, from 3.26% in early October to 2.54% in early January 2019 (figure 2, left frame), weakening the competitive attraction of a real yield. However, we observe an interesting development in 2019. While the 10-year yield has continued to fall since the beginning of the year, inflation breakevens recovered modestly, implying that real yields have been collapsing, yet gold prices have remained flat. Figure 2 (right frame) shows that the relationship between gold prices and real yields (TIPS) has broken down since early 2018. While the real yield on the 5-year Treasury bond has fallen by 30bps since mid-February, an ounce of gold has dropped by US$50 to US$1,285.
Data source: Eikon Reuters
The CFTC commitment of traders’ report shows that the net speculative longs have raised moderately in the past month, up from 37K to 89K, but still remain far below the 2016 and 2017 levels. Even though the ETF flows data shows that investors turned net buyers of gold in the past two weeks, adding a small 6 tons to their gold holdings, we observe strong outflows since the beginning of the year on the back of its dull performance. Overall, sentiment on gold is neutral and many participants, disposed to a bullish view, have lost interest after months of consecutive underperformance relative to other markets.
Data source: Eikon Reuters, CFTC, FastMarkets
To conclude, the Dollar gold price may continue to struggle against a background of elevated political uncertainty which may favour the US Dollar in the coming weeks. In addition, the risk of a sudden rebound in US yields, with the 10-year bond trading 15bps below the effective Fed Funds rate, is restraining investors from starting to build a long position at current levels (figure 4, left frame).
However, we are confident that gold prices will overcome the prevailing headwinds as sentiment turns away from the US Dollar, in the context of fading economic momentum, and its attraction as a diversifying asset is enhanced by the return of financial market volatility. Specifically, the downturn in corporate profits this year poses a direct threat to corporate equity and bond prices. We target a break above the long-term resistance zone US$1,350 to US$1,400 (figure 4, right frame) and commend gold as a zero-beta asset in wealth portfolios over the coming months.
Data source: Eikon Reuters
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