Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Precious metals supported by peak rate speculation
Ole Hansen
Head of Commodity Strategy
Summary: The precious metal sector has started to recover from its recent slump in response to bond yields turning lower following the tragic events in the Middle East and comments from several Fed members talking down the prospect for further rate hikes. Both developments have forced hedge funds to reverse recently established net short positions back to fresh longs while providing the ETF market with a glimmer of hope that months of selling could finally be running out of steam.
Global Market Quick Take: Europe
Key points in this gold note
- Precious metals have received a bid from the tragic developments in the Middle East and Fed members talking down the need for additional rate hikes
- Peak rate speculation has driven down the one-year funding cost of holding gold and it may signal returning demand from ETF investors
- We maintain a patiently bullish view on investment metals as the timing of a fresh push to the upside remains very US ecnomic data dependent.
The precious metal sector has recovered strongly following a recent slump which culminated last Friday when another surprisingly strong US job report supported the higher-for-longer narrative and which saw long-end US Treasury yields reach fresh multi-year highs. Since then, however, yields have started to reverse lower driven by the tragic events in the Middle East and comments from several Fed members mentioning the tightening impact of rising bond yields reducing the need from the FOMC to hike rates further. Both developments have forced hedge funds to reverse the recently established net short position back to a long.
In our recently published outlook for the fourth quarter, titled “Bond. Long bond(s)”, our core thesis is that real rates are too positive, creating a fallout from sectors and consumers with refinancing needs. As spending is likely to slow and the US fiscal cycle is turning from tailwind to headwind, the world may indeed have reached ‘peak rates’, providing a four-decade opportunity to go long bonds. On bonds we also noted that, the stagflation risks and ‘higher for longer’ observed through inflation expectations and lately driven by higher energy prices may pose a timing threat to our long bonds theme. However, an economic downturn, as the lagged effects of the recent rate hike cycle kick in, will force central banks into cutting interest rates, lowering the short-end of the US yield curve and, as the effects deepen, the long-end of the yield curve will follow lower, reflecting the need for lower long-term real rates or even negative real rates.
Looking at our gold, and with that also silver, monitor below, we see some encouraging signs emerging, not least the mentioned sharp reversal in long-end bond yields, which has driven some softness in real yields, one of the major long-term drivers for gold, but also the softer dollar and not least traders increasing bets on the number of rate hikes next year. The Secured Overnight Financing Rate futures (SOFR) trade higher this week, signaling a pickup in the expected pace of rate cuts next year. An example being the December 2023 versus December 2024 spread which during the past week has gone from signaling a 75 basis point cut to nearly 100 basis point.
In addition, the opportunity cost of holding non-coupon paying precious metal positions has started to weaken as short-term rates soften. The percentage difference between spot gold and gold for delivery in 12 months’ time, which reflects the cost of storage, insurance and not least funding for that duration has come down from a recent peak around 6.07% to 5.7% currently. The rising cost of funding has been a significant driver behind a year-long reduction in gold positions held by asset managers, and in recent updates we have argued that this trend would likely continued until we see a clear trend towards lower rates and/or an upside break forcing a response from real money allocators.
ETF investors which include the above mentioned group of real money allocators have been cutting holdings for the past four months, leaving the total down by a significant 224 tons during this time to 2707 tons, a 3-1/2-year low. During the same time gold has only lost 4.5% of its value in our opinion a satisfactory performance, not least considering the considerable headwinds from surging bond yields and the stronger dollar during this time. It highlights an underlying demand for gold, not only from central banks but also from traders seeking a hedge against a soft-landing failure. We maintain a patiently bullish view on gold, and with that also silver and platinum, not least supported by the view the Fed is unlikely to raise rates further as the economy begins to soften.
Spot gold, in a downward trending channel since May, has recovered strongly after finding support ahead of the February lows around $1805, but in order for the bounce to signal a fresh upside challenge it needs to make a solid break back above $1885, the August low.
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