What is happening to Gold?

For a number of weeks, if not months, I (and in fairness, many others) have been suggesting a defensive stance is warranted in the current climate, a climate which has been poisoned by not only trade tensions, but geopolitical risks which up until recent years have prompted an element of caution amongst investors at the very least.  As I covered last week, the BAML fund managers survey highlighted a more protective approach to portfolio management rather than positioning for a fresh reversal.  The end of last year, a 20% drop on Wall Steet sparked fears that the parabolic bull run of the last 8-10 years was set to change course, but a combination of ongoing corporate buybacks along with the aforementioned apathy have maintained an upside bias which at this stage does not rule out the major US indices stretching back up to new record highs. 

 

Over the near to medium term, Q2 earnings season will have to be assessed and negotiated before conviction is likely to return in full force, though a trade deal between the US and China - as unlikely as that looks at present - would likely accelerate this process.  US growth projections in the meantime have been mixed at best, with some of the early calls for Q2 GDP coming in at just a touch over 1.0% - according to the Atlanta GDP model - the most highly regarded of 'indicators' by the market.  There have been clear signals in the US economy that the economic pace of growth seen last year is slowing down.  Indeed, looking at the components of Q1 GDP, inventory build-up and the trade balance bolstered by lower imports were the major contributors to the surprise 3.2% print, which caught many by surprise until they saw the composition.  Despite this, Treasury yields have held their ground in the long end, while short to mid curve buying has helped support the Dollar.  The Dollar remains the safe haven of choice, as it continues to offer positive yield differentials, with reports of unhedged buying of foreign assets out of Japan bolstering the Dollar rate vs the Japanese Yen.  

 

The Chinese Yuan has also weakened in recent weeks as a result of the breakdown in trade talks and consequently, the markets have been of the opinion that China will continue to take a more relaxed approach to the exchange rate as a way of offsetting (in part) some of the effects of the tariffs imposed by the US.  As part of a bigger Dollar funding story where emerging market currencies are losing ground against the greenback, the appeal of the reserve currency carries with it some significant potential outright gains, resulting in some of the strong gains we have seen in the past year or so alongside the broader gains in stocks.  

 

This thirst for yield has then carried over into the precious metals markets, where shorting Gold vs the Dollar provides carry, and this dynamic will tend to win out when seasonal demand starts to tail off.  Despite this preferential flow out of the yellow metal, I continue to believe that we are in a basing process at the present time, which may indeed yet see further pressure on Gold, though the onus on investors will be to watch the performance of the US economy going forward.  Remember that even though the US is enjoying a purple patch, the debt mountain is rising by the second - currently just over $22.31trln and counting.  The US debt to GDP ratio is also inching slowing but steadily, and at present, stands at 105.47%.  This was a major issue for currency investors a little over a year ago when the greenback was suffering hard times.  Should yields start to ease off in response to economic data, while this may give US equities a temporary reprieve, it should also reinvigorate appetite for Gold and other precious metals. 

 

Technically, Gold has found some support around $1270-80, though we note stronger levels in closer to $1250 and into $1230-20.  Notable buyers just below these levels earlier this year included DoubleLine Capital, led by Jeffrey Gundlach.  It is also worth noting that the fund manager's outlook on the US economy has also incorporated concerns over US debt, something indeed Fed chairman Powell has been quietly adding into the Federal Reserve's assessment in recent press conferences.  The pressure on Gold is purely down to the market's preference for Dollars.  At some point this will reach exhaustion.  Thereafter, the impact may well be swift and dramatic.