Macro: Sandcastle economics
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Precious metals go through prolonged consolidation phase
Ole Hansen
Head of Commodity Strategy
Key points
- Precious metals undergoing an extended period of consolidation, giving traders and investors time to adapt to higher levels.
- China, a major driver of gold buying since 2022, has temporarily stepped aside, thereby removing an otherwise constant source of demand.
- Hedge funds getting onboard early and at lower levels helps explain why gold has suffered a smaller correction than silver.
- We maintain our "Year of the metal" theme with clarity about the timing and depth of incoming US rate cuts needed for additional support.
The precious metals sector is undergoing an extended period of consolidation, and following the strong run up earlier this year, this phase gives traders and investors time to catch their breath while adapting to new and higher levels. Following two unsuccessful attempts to establish support above USD 2400, gold has, since early April, seen most of its daily closes being within a USD 2280 to USD 2380 range. The biggest setback during this time was when data showed the People’s Bank of China, after 18 months of non-stop buying, paused their purchases in May.
China, a major driver of the gold rally since 2022, is in our opinion nowhere near done buying gold, and we believe the pause is mostly driven by the bank balking at the prospect of paying record prices. Also, the recent attention paid to Chinese private buying, another significant driver of demand for physical gold, has likely thrust them into a spotlight they normally avoid. Overall, gold is still consolidating, and the news will likely prolong that phase, but overall, the long-term bullish outlook has not changed.
We maintain our positive outlook for investment metals with the below drivers still the focus:
Geopolitical risks and events remain a key feature, although the price supportive impact so far has mostly been of a short-term nature
Strong retail demand in China amid the desire to park money in a sector seen as relatively immune to a struggling economy and property woes
Continued central bank demand amid geopolitical uncertainty and de-dollarisation, and not least gold’s ability to offer a level of security and stability that other assets may not provide. China’s buying pause is seen as temporary
Rising debt-to-GDP ratios among major economies, not least in the US, raising some concerns about the quality of debt. In other words, rising Treasury yields are not necessarily negative for gold as they raise the focus on overall debt levels and the sustainability of those.
In addition, the focus is changing from the negative impact of lower rate cut expectations towards support from a sticky inflation outlook.
Gold has, throughout the latest and once again shallow consolidation phase, managed to hold above technical levels, currently around USD 2280, which otherwise could have triggered long liquidation from managed money accounts, currently holding an elevated speculative long in the futures market, mostly entered at even lower levels below USD 2200
Besides the mentioned strong demand from central banks and retail investors in China, it is clear that the bulk of the run up in prices back in February and March was supported by strong demand from managed money traders, such as hedge funds. Having joined the rally at an early stage, they have subsequently not been forced to adjust (sell) positions as the current correction phase, has kept prices above levels that otherwise would have forced them to reduce their exposure.
Getting onboard early and at much lower levels helps explain why the current gold volatility is relatively low compared with other metals such as silver, platinum and copper where speculators joined a bit later, and at higher prices, leaving them more exposed to long liquidation and with that the risk of a deeper correction. Gold and silver continue to see limited interest from ETF investors who have remained mostly net sellers since 2022 when the FOMC began its aggressive rate hiking campaign, in doing so raising the cost of carry, or opportunity cost, of holding a non-coupon paying metal investment. Demand from ETF investors will likely remain subdued until interest rates are lowered, and this cost is being reduced.
Silver’s aggressive 25% rally last month continues to deflate, once again highlighting that wherever gold goes, silver goes, but faster. Still up by more than 22% year-to-date, the semi-industrial metal benefitted from the recent strong rally across industrial metals, not least copper with which silver shares some green transformation credentials. However, the copper rally became unstuck once the market realised current fundamentals, especially in China, pointed to weakness, not strength, and the subsequent correction has so far resulted in losses this month of around 3% for both silver and copper.
As mentioned above, managed money accounts or speculators were relatively late to the rally in both metals, and the need to reduce exposure, in some cases on loss-making positions, has driven both silver and copper sharply lower, with both surrendering around half the gains seen during May. The higher price volatility in silver compared with gold helped drive the gold-silver ratio from an 88 high to an August 2021 low at 72.70 last month before the mentioned silver slump helped drive it back up to the current level around79 ounces of silver to one ounce of gold.
While we maintain our “Year of the metals” theme, highlighted in our Q1 outlook, we believe the strength of the rally seen already this year with gold trading up 12%, and silver by 23%, could see an extended period of consolidation while investors and traders adjust to higher levels and while we await clarity about the number of and timing of incoming rate cuts.
Recent commodity articles:
17 June 2024: COT: Dollar long jumps; Funds start rebuilding crude long
14 June 2024: Commodity weekly: Energy sector gains counterbalance metal consolidation
13 June 2024: Oil prices steady amid divergent OPEC and IEA demand projections
10 June 2024: COT: Brent long cut to ten-year low; metals left exposed to end of week slump
3 June 2024: COT: Crude length added before OPEC+ meeting; gold and copper see profit-taking
31 May 2024: Commodity weekly: Strong month despite late decline in crude and fuel
27 May 2024: COT: Gold and crude see increased demand as dollar longs plummet
24 May 2024: Commodity weekly: agriculture surges, metals fall on fading rate cut hopes
23 May 2024: Podcast: 2024 is heavy metals
22 May 2024: Crude oil struggles near two-month low
17 May 2024: Commodity weekly: Metals lead broad gains
16 May 2024: Gold and silver rally as soft US data fuels market optimism
15 May 2024: Copper soars to record high, platinum breaks out
14 May 2024: COT: Crude long slump; grain purchases surge
8 May 2024: Fund selling exacerbates softening crude outlook
8 May 2024: Grains see bumpy start to 2024 crop year
6 May 2024: COT: Commodities correction spurs muted selling response
3 May 2024: Commodity weekly: Grains boost, correction in softs and energy
2 May 2024: Copper's momentum-fueled rally halts amid weakening fundamentals
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