Short-term traders rather than safe-haven seekers have pushed gold prides to record-highs in summer. It looks like prices have moved past their peak for now.
The recent sell-off in the gold market brought back memories of the early days of the coronavirus crisis in March. Rapidly rising infection rates and fears of broad-based lockdowns triggered a risk-off move in financial markets, putting pressure on equities and spilling over into the gold market as the US dollar strengthened. While counterintuitive at first sight, such moves are not unusual for gold in times when the risk perception in financial markets changes and investors dump risky assets for US dollars. For many investors, the US dollar itself still is a safe haven.
While a stronger US dollar and slightly higher – or rather slightly less negative – US real bond yields look like the triggers of the recent sell-off, neither the one nor the other is sufficient to explain it. Instead, the explanation is rather that trend followers and technical traders have again exited the market after piling into gold during the record run in July and early August. While gold is a safe haven which has proven its track record multiple times in the past it is likewise a financial asset which also attracts short-term and speculative traders. These traders are looking for short-term profits rather than gold’s safe-haven benefits. They amplify price moves, to the upside as well as to the downside, blurring the fundamental picture of the gold market.
The fundamental picture is still dominated by the corona crisis, the related recession and the policymakers’ response to it. Looking back, we believe a short and sharp recession was fully priced into gold at lower than today’s levels. We also believe that the summer rally was further fuelled by fears that the massive stimulus measures to fight the fallout from the corona crisis, often referred to as money printing, will inevitably lead to rapidly rising inflation, a loss of trust in the world’s currencies – most notably the US dollar – and a spike in gold prices. This money printing narrative nourished the bullish mood in the market and some even saw the recent weakness of the US dollar as a prelude to a longer-lasting debasement. We disagree. The dollar’s weakness was because of cyclical rather than structural reasons. Simply speaking, the US were dealing worse with the corona crisis than Europe, which is why the dollar was down versus the euro.
When it comes to the issue of inflation, the question for gold is if the world will face good inflation, reflecting a pick-up in economic activity, or bad inflation, resulting from the afore mentioned loss of trust in the world’s currencies. Only the latter, which we see as a rather remote risk, would be good for gold. Higher gold prices and lower real bond yields are two sides of the same coin, reflecting a flight into safety. If the economic environment continues to improve on the back of today’s massive stimulus measures, we would not be surprised if the currently close relationship between gold and real US bond yields broke down.
Rather than the US dollar or real US bond yields, it is the investors’ demand for gold as a safe haven, which is primarily driving prices. And the demand is very much determined by the economic environment, whereby rising risks lead to increasing investments into gold and vice versa. As we expect a continued improvement of the economic environment despite a prevailing pandemic, safe-haven demand should fade and prices should move somewhat lower over the coming months. For now, it looks like prices have moved past their peak even though we acknowledge the fight against the corona crisis could sow the seeds for a new financial crisis in a few years’ time.
Carsten Menke, CFA, Head of Next Generation Research, Bank Julius Baer