Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Gold remains troubled but headwinds unlikely to persist
Ole Hansen
Head of Commodity Strategy
Summary: Golds failure to rally over the past few weeks, as the Covid19 spread and economic uncertainty rose, has triggered a great deal of uncertainty about what role gold can play. In the short-term the market is being challenged by a continued demand to raise cash and rising real yields as inflation expectations take a tumble. We maintain a positive outlook and draw some parallels what happened during and after the great financial crisis in 2008 and 2009.
Gold’s failure to rally over the past few weeks, as the Covid-19 spread and economic uncertainty rose, has brought back memories of the 2008 Great Financial Crisis. During the early part of the 2008-09 crisis all assets were sold as a result of the need to deleverage in order to realise cash or pay for losses elsewhere. In the early weeks of the crisis gold suffered a 27% sell-off to $725/oz before beginning the ascent which eventually took it to $1920/oz.
The rally started in gold mining stocks before moving to gold and it took another few months before the stock market finally bottomed out. With this in mind we are keeping a close eye on gold mining stocks, through the Vaneck Major Gold Miners ETF (Ticker: GDX:arcx). Yesterday it slumped to a 49% loss from the February peak before recovering to finish the day higher up by 18.5%.
Whether the low is in remains to be seen but the sharp recovery indicated that buyers had been waiting for the opportunity. While gold has fallen we also have to keep in the mind that the cost of fuel, which account for 20% of the mining cost, has collapsed. Gold miners have therefore, at least for now, not suffered the hit that the drop in gold would otherwise imply.
Gold has now been through a 15% top to bottom sell-off before - at least for now - once again finding support at $1450/oz. The correction has obviously once again raised the question of whether gold is worth it’s tag as a safe-haven and diversifier. We believe the long term reasons for holding gold has if anything been strengthened by current developments.
However, as mentioned, the main driver behind gold’s recent weakness has been the “dash for cash”. A move that was strengthened by the elevated leveraged positions that had been built up in gold during the past few months. In my latest COT report covering the week to March 10 I highlighted how deleveraging had become the overriding theme with both long and short positions being reduced. The biggest long reductions were seen in crude oil, gold, sugar, cocoa and cotton while short-covering was seen in natural gas, soybeans and corn.
The open interest in COMEX gold futures has dropped to 573,00 lots, the lowest since last July. A sign that positions, both long and short have now seen a significant reduction from the January peak at 800,000 lots.
The difficulty in fully understanding the sudden weakness and temporary loss of safe haven status have raised some concerns that the link between cash and paper is under pressure. While paper gold has seen a significant amount of selling the cash market has reacted to developments across the different regions. Discounts have been offered in Asia and India while dealers in Dubai have noticed a premium in recent days. Overall we conclude that the Covid19 has triggered a significant disruption to supply chains and logistics. Major buyers have temporary close down their borders while others have witnessed a slump in demand. Against these developments the supply chain is also severely stressed with shipments being held back and not reaching their destination, in this case Dubai.
Spot gold is currently heading for the highest daily close in seven years above $1660/oz. With another 50bp rate cut already priced in the prospect for additional gains depend on continued safe-haven demand. With this in mind the U.S. stock market performance hold the key to further gains.
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