Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Gold’s surge driven by global bond yield collapse
Ole Hansen
Head of Commodity Strategy
Summary: Gold’s rally to a six-year high remains mostly a bond story and for investors it is critical to keep an eye on the events, such as trade developments and central bank actions, that drive yields in order to determine what happens next.
Gold has been putting in a very strong performance during the past couple of months. Support has been provided by the race to the bottom in global yields and central banks switching back to easing mode. After rallying by close to 19% this year and 8% this quarter alone the price has reached levels last seen in April 2013. The GDX ETF which tracks major gold mining companies have rallied by 37% YTD and 13.5% this quarter.
The drop in global bond yields has resulted in close to $16 trillion worth of global bonds, especially from Europe and Japan, now yielding less than zero. This development combined with worries that global stocks may struggle amid slowing global growth and a prolonged US-China trade war has created a very friendly investment environment for gold. Current developments in Hong Kong together with the safe-haven bid for Japanese Yen have also been playing a part.
The below chart shows the increased investor appetite for “paper” gold through futures (hedge funds) and Exchange-traded Funds (ETF). Hedge funds have accumulated a near record amount of exposure through COMEX gold futures during the past few months while total ETF holdings have witnessed a steady increase to the current level of 77.4 million ounces, a six-year high.
For investors in gold these developments represent one of the few clouds on the current horizon as previous spikes in speculative involvement have triggered a subsequent correction. What makes it different this time is the falling opportunity cost due to low yielding bonds and the increased risk of a recession.
The correlation between US 10-year real yields and gold – shown below - is another way off highlighting the diminishing opportunity cost of holding non-yielding gold versus bonds.
Having reached $1485/oz, the target mentioned in our Q3 Outlook gold has continued to move higher with the next target from a long-term technical perspective being $1587/oz, the 61.8% retracement of the 2011 to 2015 sell-off. The market is clearly in need of consolidation so any reversal in bonds and/or dollar strength may increase the temptation to book some profit. Just like $1380/oz was the support following the July breakout the next support level to focus on now is $1485/oz as per the chat below. A break below that level is likely signal a period of consolidation but at this stage not a reversal.
In this Bloomberg Opinion piece from today the author highlights how negative yields are a painfully obvious sign that governments have room to take on more debt to improve infrastructure and fight climate change. If realized – keep an eye on Germany - such a development, which was mentioned by Steen Jacobsen in our Q3 Outlook, could trigger some inflationary pressures and with that create the foundation for even higher gold prices.
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