Sive Morten
Special Consultant to the FPA
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Fundamentals
As gold as other markets now catch carefully everything that comes from different central banks. ECB has made its session already while BoE and Fed are yet to come. Currently, I mean Sep-Oct-Nov we have high density of important events that have all chances to change the shape of the markets. Even now major events already show surprises. For instance, Brexit negotiations are turning to worse way, compares to what have expected previously. US steps in the game and we already see that UK has the only way to adopt Brexit - set the border in Ireland see and so on. And what is yet to come around US elections and other events.
Today we should take a look at situation from perspective of coming Fed meeting. ECB has not provided any new stimulus and this was relatively negative signs for gold.
Gold prices dipped on Friday after the European Central Bank stopped short of offering any concrete signals on further stimulus, but lingering economic uncertainties kept the metal on track for a weekly rise. ECB President Christine Lagarde played down concerns about the euro's strength and disappointed hopes for more stimulus.
The U.S. Senate blocked a Republican bill that would have provided around $300 billion in new coronavirus aid.
"The ECB did not address the stronger euro, neither did it come up with any stimulus plans, which will keep inflation in check in the euro zone. That's negative for gold," said Quantitative Commodity Research analyst Peter Fertig.
"While COVID-19 vaccine developments and improving economic data present near-term headwinds to gold, low and negative interest rates, a weaker USD, and expectations for further stimulus keep the balance of risks to the upside," Standard Chartered said in a note.
"We are transitioning into a post-COVID type of environment. That means we're not going to be pumping out the same stimulus, that signals to the market that things are going to be a little different going forward," said Daniel Pavilonis, senior market strategist at RJO Futures. Pavilonis said gold could touch $2,300 an ounce by year-end on uncertainty surrounding equity markets, the economy and the November U.S. elections.
Investors are now awaiting the U.S. Federal Reserve's policy meeting next week, on Sept. 15-16.
"The labor market recovery has completely stalled, the Congress has delivered zero extra dollars since the last Fed meeting, and there's going to be a lot more pressure for the Fed to maintain an accommodative stance," Moya said.
“A higher dollar is weighing on gold, while longer-term uncertainties still persisting in the market is putting a floor under prices,” Carsten Menke, analyst at Julius Baer, said. Menke said gold is likely to trade sideways “as recessionary fears have already been priced in and investors are now waiting to see what happens next in term of central bank policies”.
If the U.S. Federal Reserve does not announce any fresh fiscal push... gold will face some headwinds,” said OANDA analyst Craig Erlam.
“Inflation expectations have come down a bit and with that real yields move higher, and that’s also having a small negative impact on gold,” said Saxo Bank analyst Ole Hansen. “So far, the selling we’ve seen is mostly light profit taking, (and) the overriding gold supportive theme has not gone away, that also means we don’t expect a deep correction as such.”
Also on investors’ radar, U.S. President Donald Trump on Monday again raised the idea of decoupling the U.S. economy from China.
COT Report
This week we do not have sharp changes in investors' positions. Open interest has dropped, but speculators have opened 3K long positions, while hedgers vice versa - decreased positions in both direction. It could be the sign that hedgers do not expect strong action in any direction, and, in turn, that Fed statement could be mostly the same and make no significant impact on the markets, as ECB one. So, we'll see. Maybe this is just position's contraction before Fed.
Fundamental price of Gold
We were talking a lot about our medium term view with explanations of factors that we think are important now and that should lead gold to suggested price by our opinion. Now they are pretty the same. Supposedly low rates, a lot of stimulus, political tensions should still have enough momentum to push gold slightly higher, somewhere to $2.3K area. At the same time, our scrutiny analysis shows, that gold stands not in the beginning of long-term upside cycle but at the end of it. Yes, this final stage also could be long enough and take 1-2 years, but still this is the final stage of rally that started in 1990's.
At the same time another question is rising - what to expect on a longer-term and what way is correct to measure the price of the gold. Is there any tool that could tell us at any moment of time, whether gold is cheap or expensive? Recently Bloomberg has published good article on this subject that provides view of respectable entities on gold price. All approaches to real gold price calculation are based on some indexation. As a rule gold stands in relation to either real interest rates or inflation. Thus, price is estimated based on these two factors.
Here is opinion of Pimco economist, Nicholas J. Johnson:
Our framework is based on our assessment that while many factors influence the price of gold, only one explains the majority of moves over the past decade: changes in the real (i.e., difference between nominal yields and inflation that is called as inflation-adjusted) yield of government bonds. Since about 2006, gold has traded like an asset with nearly 30 years’ real duration (meaning that a 100-basis-point move lower in U.S. Treasury real yields has translated to a roughly 30% increase in the price of gold). From a market perspective, as real yields on U.S. government bonds rise, one would expect investors to marginally prefer those assets, moving out of gold and into U.S. Treasuries and Treasury Inflation-Protected Securities (TIPS). Gold prices should drop in the process. Conversely, when Treasury real yields fall, gold prices would tend to climb.
The chart below illustrates that while the spot price of gold has soared recently (as Treasury yields sank), the real-yield-adjusted price of gold (the gold price discounted by the level of real yields for its empirical duration) has held quite steady. We think it’s likely, however, that its real-yield-adjusted price could move higher within that band, as gold’s recent strong performance attracts more interest in the market, similar to what occurred following the 2008 financial crisis.
Despite the recent run-up in gold prices, we believe gold remains attractively valued – one might even say cheap – in the context of historically low real interest rates. The key risk is that real interest rates rise, making gold relatively less attractive. At current valuations, however, there is some cushion against this view, with the real-yield-adjusted gold price at the lower end of its range for the last 15 years. Our base case is that rates remain relatively range-bound; this outlook, combined with our view that momentum and interest in gold causes the real-yield-adjusted gold price to move higher, points to gold still having more upside from here.
This process leads to the finding that gold is cheap. In the following chart, the blue line shows nominal gold, while the green line shows the price discounted by the level of the real yield for its empirical duration. If investors grow as scared about monetary debasement as they did a decade ago, a development that is easy to imagine, then gold could rise further. In real yield-adjusted terms it is now at the bottom of its recent range. Why shouldn’t it return to the top if sentiment sours?
But it is not as simple. Another approach that uses CPI index instead shows different picture. It suggests a framework based around the “real price of gold.” This price is a notional accounting identity. If we know the price and earnings of a stock, then we also know its price-earnings ratio. Similarly, they argue, if we know the level of gold and of the consumer price index, then dividing the first by the second gives us the real price. When gold was $1,800.50 in June, and the price index was 257.2, the real gold price was 7. In January 1975, it stood at only 3.36, so in real terms gold is much more expensive than it used to be.
Using this methodology, this is how the the real gold price has moved over time:
Thus, the real gold price is almost as high as at its two previous peaks, in 1980 and after the crisis. Unlike the Pimco methodology, then, this approach finds that gold is already very expensive.
What it has in common is that it finds the launch of gold ETFs, making speculation in gold far easier, was a moment when something important changed. This chart shows the correlation of the real gold price, as they define it, with the holdings of the two biggest gold ETFs. The correlation is significantly tighter even than the link with real yields:
If lots more people decide to try their luck with gold ETFs, this chart implies, the real price could go much higher. This would be an example of speculative excess, similar to what happened in 1980, and driven more by fear of disaster than by greed. Meanwhile, this approach suggests that shifting inflation levels and expectations don’t matter anything like as much. If we look at inflation, nominal gold prices, and the real gold price by this recent CPI indexation approach over time, we see that inflation is almost inconsequential compared to swings in the real price:
What of the obvious correlation with real yields? Michael Howell of CrossBorder Capital Ltd. in London suggests that causation runs the opposite way. As he puts it: “Moves in the gold price drive real yields.” He instead suggests that gold is a phenomenon of financial liquidity. When more money is available, the price will be higher, and vice versa. Rather than price gold in terms of fiat or paper money, he says, we should view paper money as being priced in terms of gold. The more money is in circulation, the higher will be the price of gold in terms of paper money. Here is the gold price since 1965, compared to inflation over the same period, and Howell’s measure of liquidity, which combines figures from the Federal Reserve, the People’s Bank of China, the European Central Bank, the Bank of Japan, the Bank of England and the International Monetary Fund. It appears far more closely linked to liquidity:
But at present, gold is deviating below the trend in liquidity, which — as measured by the broad M2 indicator — just shot through the roof.
Howell suggests four factors can be shown to drive speculative interest in gold. First, each 1 percentage point rise in the future trend of inflation over the next year tends to increase the gold price by about 2% — so an increase in expected inflation from 2% to 3%, which would currently seem like an epochal shift, would be good only for a move of about $50 in gold.
Second, unsurprisingly, deteriorating risk appetite over the preceding two years leads to higher gold prices. The massive loss of confidence during the Covid crash naturally led to greater demand for gold. Third, there is the Fed’s balance sheet, and fourth there is “flight capital” from emerging markets, China in particular. His conclusion is as follows:
To bet against gold at this point is to bet that central banks reverse course swiftly and start mopping up liquidity and even raising interest rates — a realistic possibility only if the pandemic comes swiftly under control, and unambiguous inflation pressures recur. Absent a swift victory over the virus, all of these three varied methodologies suggest that there is far more room for gold to rise than to fall.
That's being said, guys we could easily specify factors and conditions that will be gold friendly and should let us to understand whether trend stands the same or it starts to change. In terms of interest rates we need combination of rising inflation expectations and stable or decreasing interest rates. So that difference between nominal interest rates and inflation becomes more negative. As Fed currently doesn't care about inflation and it is rising slowly (as we saw last week, based on forward interest rates), Fed intends to keep bonds' buying programme that will hold nominal rates low. From this point of view we have positive combination for the gold and need to keep an eye on these rates and Fed steps.
Second is liquidity - preferably if Fed provides more stimulus. As previously taken measures are ended and employment starts dropping again, based on recent Initial claims numbers, new help pack is stumbled in Senate, Fed has no choice but should provide, or at least announce supportive measures. In this case we could count on upside continuation. But, if even everything will stay the same - gold should drift higher, maybe not as fast as previously. Even existed factors have long-term durable impact that still holds.
Technical part in next post
As gold as other markets now catch carefully everything that comes from different central banks. ECB has made its session already while BoE and Fed are yet to come. Currently, I mean Sep-Oct-Nov we have high density of important events that have all chances to change the shape of the markets. Even now major events already show surprises. For instance, Brexit negotiations are turning to worse way, compares to what have expected previously. US steps in the game and we already see that UK has the only way to adopt Brexit - set the border in Ireland see and so on. And what is yet to come around US elections and other events.
Today we should take a look at situation from perspective of coming Fed meeting. ECB has not provided any new stimulus and this was relatively negative signs for gold.
Gold prices dipped on Friday after the European Central Bank stopped short of offering any concrete signals on further stimulus, but lingering economic uncertainties kept the metal on track for a weekly rise. ECB President Christine Lagarde played down concerns about the euro's strength and disappointed hopes for more stimulus.
The U.S. Senate blocked a Republican bill that would have provided around $300 billion in new coronavirus aid.
"The ECB did not address the stronger euro, neither did it come up with any stimulus plans, which will keep inflation in check in the euro zone. That's negative for gold," said Quantitative Commodity Research analyst Peter Fertig.
"While COVID-19 vaccine developments and improving economic data present near-term headwinds to gold, low and negative interest rates, a weaker USD, and expectations for further stimulus keep the balance of risks to the upside," Standard Chartered said in a note.
"We are transitioning into a post-COVID type of environment. That means we're not going to be pumping out the same stimulus, that signals to the market that things are going to be a little different going forward," said Daniel Pavilonis, senior market strategist at RJO Futures. Pavilonis said gold could touch $2,300 an ounce by year-end on uncertainty surrounding equity markets, the economy and the November U.S. elections.
Investors are now awaiting the U.S. Federal Reserve's policy meeting next week, on Sept. 15-16.
"The labor market recovery has completely stalled, the Congress has delivered zero extra dollars since the last Fed meeting, and there's going to be a lot more pressure for the Fed to maintain an accommodative stance," Moya said.
“A higher dollar is weighing on gold, while longer-term uncertainties still persisting in the market is putting a floor under prices,” Carsten Menke, analyst at Julius Baer, said. Menke said gold is likely to trade sideways “as recessionary fears have already been priced in and investors are now waiting to see what happens next in term of central bank policies”.
If the U.S. Federal Reserve does not announce any fresh fiscal push... gold will face some headwinds,” said OANDA analyst Craig Erlam.
“Inflation expectations have come down a bit and with that real yields move higher, and that’s also having a small negative impact on gold,” said Saxo Bank analyst Ole Hansen. “So far, the selling we’ve seen is mostly light profit taking, (and) the overriding gold supportive theme has not gone away, that also means we don’t expect a deep correction as such.”
Also on investors’ radar, U.S. President Donald Trump on Monday again raised the idea of decoupling the U.S. economy from China.
COT Report
This week we do not have sharp changes in investors' positions. Open interest has dropped, but speculators have opened 3K long positions, while hedgers vice versa - decreased positions in both direction. It could be the sign that hedgers do not expect strong action in any direction, and, in turn, that Fed statement could be mostly the same and make no significant impact on the markets, as ECB one. So, we'll see. Maybe this is just position's contraction before Fed.
Fundamental price of Gold
We were talking a lot about our medium term view with explanations of factors that we think are important now and that should lead gold to suggested price by our opinion. Now they are pretty the same. Supposedly low rates, a lot of stimulus, political tensions should still have enough momentum to push gold slightly higher, somewhere to $2.3K area. At the same time, our scrutiny analysis shows, that gold stands not in the beginning of long-term upside cycle but at the end of it. Yes, this final stage also could be long enough and take 1-2 years, but still this is the final stage of rally that started in 1990's.
At the same time another question is rising - what to expect on a longer-term and what way is correct to measure the price of the gold. Is there any tool that could tell us at any moment of time, whether gold is cheap or expensive? Recently Bloomberg has published good article on this subject that provides view of respectable entities on gold price. All approaches to real gold price calculation are based on some indexation. As a rule gold stands in relation to either real interest rates or inflation. Thus, price is estimated based on these two factors.
Here is opinion of Pimco economist, Nicholas J. Johnson:
Our framework is based on our assessment that while many factors influence the price of gold, only one explains the majority of moves over the past decade: changes in the real (i.e., difference between nominal yields and inflation that is called as inflation-adjusted) yield of government bonds. Since about 2006, gold has traded like an asset with nearly 30 years’ real duration (meaning that a 100-basis-point move lower in U.S. Treasury real yields has translated to a roughly 30% increase in the price of gold). From a market perspective, as real yields on U.S. government bonds rise, one would expect investors to marginally prefer those assets, moving out of gold and into U.S. Treasuries and Treasury Inflation-Protected Securities (TIPS). Gold prices should drop in the process. Conversely, when Treasury real yields fall, gold prices would tend to climb.
The chart below illustrates that while the spot price of gold has soared recently (as Treasury yields sank), the real-yield-adjusted price of gold (the gold price discounted by the level of real yields for its empirical duration) has held quite steady. We think it’s likely, however, that its real-yield-adjusted price could move higher within that band, as gold’s recent strong performance attracts more interest in the market, similar to what occurred following the 2008 financial crisis.
Despite the recent run-up in gold prices, we believe gold remains attractively valued – one might even say cheap – in the context of historically low real interest rates. The key risk is that real interest rates rise, making gold relatively less attractive. At current valuations, however, there is some cushion against this view, with the real-yield-adjusted gold price at the lower end of its range for the last 15 years. Our base case is that rates remain relatively range-bound; this outlook, combined with our view that momentum and interest in gold causes the real-yield-adjusted gold price to move higher, points to gold still having more upside from here.
This process leads to the finding that gold is cheap. In the following chart, the blue line shows nominal gold, while the green line shows the price discounted by the level of the real yield for its empirical duration. If investors grow as scared about monetary debasement as they did a decade ago, a development that is easy to imagine, then gold could rise further. In real yield-adjusted terms it is now at the bottom of its recent range. Why shouldn’t it return to the top if sentiment sours?
But it is not as simple. Another approach that uses CPI index instead shows different picture. It suggests a framework based around the “real price of gold.” This price is a notional accounting identity. If we know the price and earnings of a stock, then we also know its price-earnings ratio. Similarly, they argue, if we know the level of gold and of the consumer price index, then dividing the first by the second gives us the real price. When gold was $1,800.50 in June, and the price index was 257.2, the real gold price was 7. In January 1975, it stood at only 3.36, so in real terms gold is much more expensive than it used to be.
Using this methodology, this is how the the real gold price has moved over time:
Thus, the real gold price is almost as high as at its two previous peaks, in 1980 and after the crisis. Unlike the Pimco methodology, then, this approach finds that gold is already very expensive.
What it has in common is that it finds the launch of gold ETFs, making speculation in gold far easier, was a moment when something important changed. This chart shows the correlation of the real gold price, as they define it, with the holdings of the two biggest gold ETFs. The correlation is significantly tighter even than the link with real yields:
If lots more people decide to try their luck with gold ETFs, this chart implies, the real price could go much higher. This would be an example of speculative excess, similar to what happened in 1980, and driven more by fear of disaster than by greed. Meanwhile, this approach suggests that shifting inflation levels and expectations don’t matter anything like as much. If we look at inflation, nominal gold prices, and the real gold price by this recent CPI indexation approach over time, we see that inflation is almost inconsequential compared to swings in the real price:
What of the obvious correlation with real yields? Michael Howell of CrossBorder Capital Ltd. in London suggests that causation runs the opposite way. As he puts it: “Moves in the gold price drive real yields.” He instead suggests that gold is a phenomenon of financial liquidity. When more money is available, the price will be higher, and vice versa. Rather than price gold in terms of fiat or paper money, he says, we should view paper money as being priced in terms of gold. The more money is in circulation, the higher will be the price of gold in terms of paper money. Here is the gold price since 1965, compared to inflation over the same period, and Howell’s measure of liquidity, which combines figures from the Federal Reserve, the People’s Bank of China, the European Central Bank, the Bank of Japan, the Bank of England and the International Monetary Fund. It appears far more closely linked to liquidity:
But at present, gold is deviating below the trend in liquidity, which — as measured by the broad M2 indicator — just shot through the roof.
Howell suggests four factors can be shown to drive speculative interest in gold. First, each 1 percentage point rise in the future trend of inflation over the next year tends to increase the gold price by about 2% — so an increase in expected inflation from 2% to 3%, which would currently seem like an epochal shift, would be good only for a move of about $50 in gold.
Second, unsurprisingly, deteriorating risk appetite over the preceding two years leads to higher gold prices. The massive loss of confidence during the Covid crash naturally led to greater demand for gold. Third, there is the Fed’s balance sheet, and fourth there is “flight capital” from emerging markets, China in particular. His conclusion is as follows:
This adds up, naturally, to a very bullish prognosis. Howell thinks gold should reach $2,500 by the end of next year buoyed by liquidity alone, and could get to $3,000 if the various cyclical factors help it to overshoot.What these factors tell us is that at times when US investor sentiment is structurally depressed; when global financial conditions are deteriorating sufficiently fast to stimulate a hunt for ‘safe’ havens, and when the Fed is trying to boost financial markets (and possibly also weaken the US dollar) with more liquidity, the gold price trades above its liquidity-based trend. This is happening right now, since all three boxes can be ticked. In addition, if and when inflation accelerates, expect a further overshoot in gold.
To bet against gold at this point is to bet that central banks reverse course swiftly and start mopping up liquidity and even raising interest rates — a realistic possibility only if the pandemic comes swiftly under control, and unambiguous inflation pressures recur. Absent a swift victory over the virus, all of these three varied methodologies suggest that there is far more room for gold to rise than to fall.
That's being said, guys we could easily specify factors and conditions that will be gold friendly and should let us to understand whether trend stands the same or it starts to change. In terms of interest rates we need combination of rising inflation expectations and stable or decreasing interest rates. So that difference between nominal interest rates and inflation becomes more negative. As Fed currently doesn't care about inflation and it is rising slowly (as we saw last week, based on forward interest rates), Fed intends to keep bonds' buying programme that will hold nominal rates low. From this point of view we have positive combination for the gold and need to keep an eye on these rates and Fed steps.
Second is liquidity - preferably if Fed provides more stimulus. As previously taken measures are ended and employment starts dropping again, based on recent Initial claims numbers, new help pack is stumbled in Senate, Fed has no choice but should provide, or at least announce supportive measures. In this case we could count on upside continuation. But, if even everything will stay the same - gold should drift higher, maybe not as fast as previously. Even existed factors have long-term durable impact that still holds.
Technical part in next post