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ABC Bullion

Where to Next for Gold?

16 November 2018

It’s been another volatile week for precious metal prices, with gold at one point falling below USD $1,200oz, before rallying to current levels around USD $1,215oz.

Silver has also been affected, trading as low as USD $13.90oz, though like gold it has reversed the losses seen earlier in the week, and last traded at USD $14.40oz.

In local currency terms, gold and silver are trading at AUD $1,670oz and AUD $19.78oz respectively, marginally down on their prices from last Friday, with the Australian dollar continuing its recent climb, currently sitting at USD $0.7274.

Stock market volatility has been a key driver of the yellow metal, with US equities rallying for the first time in six days overnight, though still on track to end the week down over 2%.
European stocks have also had a tough week, whilst in the United Kingdom, the FTSE 250 index and GBP suffered large falls overnight, as the continued fallout from Brexit negotiations saw a handful of cabinet ministers in the UK resign.

Equity market weakness has also been seen in Australia this week, with the ASX last trading at 5736 points, down nearly 200 points, or some 3%, from levels seen on November 9th.

The performance of the ASX over the last 12 months can be seen in the chart below, with the market now down 10% from the late August highs.

S&P/ASX
 
We spend a lot of time monitoring equity market developments because they will likely be a key driver of the gold price in the coming months and years.

If the recent volatility in risk assets does continue, and should equities continue to struggle, then it is very likely that gold will outperform, as investors seek wealth protection.

Indeed, gold outperforming the stock market is one of key indicators we see as and when precious metals are entering a bull market phase, with this article on CNN titled: “Gold is Back. That’s a worrying sign” quoting Natalie Dempster from the World Gold Council who stated that: “Stock market volatility has pushed more people to gold. Any further wobbles on Wall Street could lead to more demand for gold going forward.”

Another catalyst could be managed money speculators, who may continue to unwind their short positions.

The current set up with managed money longs and shorts can be seen in the chart below, which shows positioning on both sides of the market over the last few years.
 
Managed money longs

In case the chart is difficult to read, the grey lines are managed longs, and the red lines managed money shorts.

As you can see on the chart, by August 2018 managed money shorts were short almost 20 million ounces of gold, equivalent to over 600 tonnes of the yellow metal.

They’ve since unwound their positions to a degree, but the net position (the sum of longs minus shorts) is still short a few million ounces, which is typically though not always a bullish situation for the market to find itself in. 

One word of caution there though is the lack of conviction on the long side. As you can see, managed money longs didn’t meaningfully add to their positions during the October rally, suggesting a lack of conviction in the bullish case for the yellow metal.

Inflation and movements in real yields are also going to be key drivers. If continued strength in the US labour force and higher wage growth feeds through to higher CPI, and/or if the Fed feels the need to slow down its monetary tightening, then that would also be supportive.

The chart below, which shows the performance of gold and US Treasury inflation indexed bonds highlighting the clear relationship between the two.
 
the performance of gold and US Treasury inflation

The other driver to watch will of course be the US Dollar. Currently sitting just below 97, the Dollar index has been in a sustained uptrend for the majority of the year, as you can see on the chart below.
 
US Dollar Index

Should further upside in the USD come to pass, then it will likely constrain returns for precious metal bulls, though we think there is a decent chance that the USD rally peters out in the coming weeks and months, which will help the sector.

Before finishing this update, we wanted to share a few comments from an excellent update provided by Chris Weston, head of research at Pepperstone Group, who this week made a “Case for Gold” heading into 2019.

Weston noted that: “being long gold has been a tough investment since 2012, and so often, when we see the yellow metal gaining traction, the [U.S. dollar] regains its mojo, and we see the inevitable reversal. However, as we look into our crystal ball and gaze into 2019, emerging warning signs can be seen that suggest 2019 could be the year where gold bulls finally get their day in the sun.”

Chris’s update notes the net short position in gold markets, the current strength in the USD, which he suggests may ease into 2019, rising US fiscal deficits, the re-emergence of currency war fears, and a flattening of the US yield curve, all of which could push gold prices higher. 

To be clear, this update isn’t an out and out bullish argument for precious metals, nor a suggestion that the market will rally imminently, with Chris noting that: “Clearly, we are not at the point of accumulating gold assets with any conviction. In fact, we may not even get there, but my view is that a Fed hiking to close the output gap at a time when we see vulnerabilities both internally and externally.
 
And at a time when excess liquidity is falling, and USD funding is high, suggests once the USD falls out of favour and there are no clear alternatives then gold will rally hard. The US unemployment rate is our trigger.
 
The weekly chart gives great perspective and there is little reason to buy now. That said, I am a buyer through $1238, but the real kicker comes if and when the unemployment rate starts to react to tighter monetary conditions, and that may be some months off yet.“

 
We’d recommend you take a read of his note in full at this link.

Until next time.

Jordan Eliseo
Chief Economist
ABC Bullion

Jordan
Disclaimer
This publication is for educational purposes only and should not be considered either general or personal advice. It does not consider any particular person’s investment objectives, financial situation or needs. Accordingly, no recommendation (expressed or implied) or other information contained in this report should be acted upon without the appropriateness of that information having regard to those factors. You should assess whether or not the information contained herein is appropriate to your individual financial circumstances and goals before making an investment decision, or seek the help the of a licensed financial adviser. Performance is historical, performance may vary, and past performance is not necessarily indicative of future performance. Any prices, quotes, or statistics included have been obtained from sources deemed to be reliable, but we do not guarantee their accuracy or completeness.