Commodities | Jul 04 2016
By Greg Peel
Everyone was surprised by the Brexit vote but no one was surprised when gold leapt to over US$1300/oz in a flash as a result. When it comes to global uncertainty, it is prudent to rush into a safe haven first and then reassess the circumstances later, rather than to be trampled in the rush.
We need only go back a couple of months to find analysts mostly talking gold down – extending the bear market run that began in 2013 – as the Fed looked to raising its cash rate several times. While rising US interest rates imply, by default, a stronger US dollar, and thus mathematically a weaker USD gold price, we might also consider Fed rate rises as representing a tentative “end to the GFC” after seven years.
Gold was popular to hold during the significant uncertainty of 2008 and for various reasons beyond including such things as the Grexit scare and the US credit rating downgrade. As post-GFC fear began to fade, gold’s appeal as a safe haven quickly began to subside. The price fell from US$1800/oz at the beginning of 2013 to US$1200 at the beginning of 2014, and was trading below US$1100 earlier this year, with much talk of triple digits looming.
Now it’s back hovering over US$1300. For a brief moment this week it looked as if gold might fall back below US$1300 once more as global stock markets rebounded from their initial panic drops but still the metal is holding its ground. And that’s not hard to understand. Equity markets may have rebounded but global Brexit fallout uncertainty has by no means faded.
But now that gold has adjusted for such a risk, brokerages and research houses across the globe have been falling over themselves to upgrade their gold price forecasts, and for the most part suggest the gold revival rally is not over yet. Inflows into gold exchange traded funds (ETF) are already running at the fastest pace on record, Deutsche Bank notes, at an annualised rate, year to date, of 29.7moz, far exceeding the previous record of 20.8moz in 2010.
Gold positioning via the futures market on Comex reached a new high of 33.5moz on June 21, UBS notes.
And then along comes the Brexit vote, and the gold price spikes. But despite all the ongoing uncertainty as to what happens next, gold has only managed to jump from around US$1280 to around US$1320 and held there. If every man and his dog are talking up gold, why isn’t it moving higher?
Well that question to a large extent has already been answered above. Every man and his dog might be talking up gold but every man and his dog is already long. When trades become “crowded”, further movement is restricted by those first movers who take profits on any further gain.
A second reason is that while there is little doubt uncertainty abounds, opinions on what the ultimate fallout from Brexit will be range from a minor disruption to the end of the world as we know it. Some say the UK will descend into recession, others say the devalued pound will provide a great economic boost. Some say the EU will now disintegrate, others say that’s rubbish. The point is, even the uncertainty is uncertain. Thus gold has made its price adjustment but no one wants to be caught long if it turns out the panic was all overblown.
UBS posed the rhetorical question this week “Shouldn’t gold be higher?” The response from UBS global strategist Joni Teves is this:
“The short answer is yes, we think so. But for now, the combination of uncertainty, volatility and potential lack of liquidity across markets as a result of the UK's vote to leave the EU have kept participants cautious and less willing to take significant positions until ample time has passed to digest recent developments.”
That about sums it up. But Teves still believes that after a period of consolidation, and some reduction in the sheer extent of long gold positions being currently held, gold will have to move higher. Despite this year’s surge back into the metal, anecdotally UBS finds that many market participants are still underweight gold. And the 33.5moz now held as futures may be a Comex record in a volume sense, but only represents 77% of the 2011 record in dollar terms.
Beyond that, UBS’ opinion echoes that of most of its peers.
Let’s start with the Fed.
Wall Street was perplexed back in April when the Fed seemed to turn very hawkish despite a weak first quarter US GDP. It was mostly about the jobs numbers, which continued to be solid, and about inflation expectations boosted by the first signs of actual wage growth. The market was cautious but the Fed appeared to be assuming four rate hikes in 2016, starting in June.
Or maybe not starting in June. There was this thing in June that might just prompt the Fed into holding off in case it went the wrong way – the Brexit vote. Okay, so July then.
Then came the shockingly weak May jobs number. Maybe not July then, maybe September. Sure enough, the Fed didn’t hike in June, citing the Brexit vote as a major reason. We know what happened next.
Goldman Sachs still believes the Fed will raise once in 2016, but not before December. Macquarie has also pushed its expectation out to December. The magnitude of Brexit fallout will certainly not be known by July, Macquarie suggests, and probably not by September. But there are now many in the market who believe there won’t be a rate rise at all in 2016.
Since the Brexit result, central banks across the globe have all assured they are ready to act if necessary. It is expected the Bank of England will have to cut its interest rate and possibly reintroduce QE. The Brexit gave investors yet another reason to push up the yen, much to the exasperation of the Bank of Japan, hence it is expected the BoJ will also have to act once more.
The ECB has claimed to be relieved markets have not crashed further than they did, and that equity markets have rebounded, but given Europe has been hardest hit to date by Britain’s decision, further ECB stimulus may also be necessary. And when the world’s attention was turned elsewhere on Brexit Friday night, The PBoC quietly slipped through another renminbi devaluation.
Before the Brexit vote, cash rates in Japan and much of Europe were already in the negative. The German ten-year yield traded into the negative. Since the vote, the US ten-year yield has fallen to 1.45% from 1.75% and stayed there. Bond markets are anticipating further monetary easing across the globe. How, then, can the Fed raise its own rate in such an environment?
While all agree the Brexit is not another GFC – credit markets are operating freely – the difference between now and 2008 is that central banks had plenty of room to move back then to provide monetary stimulus. Now, they have none. Negative rates are already being criticised as counterproductive given rather than encouraging commercial banks to lend, they are imposing a tax on those banks. QE cupboards are already stuffed full.
But this is not discouraging assumptions of further central bank stimulus. Goldman Sachs and Macquarie are among those now assuming no Fed rate hike until December. Others are saying no rate hike until 2018. Still others are saying the Fed’s next move will be to cut, back to zero again.
This all adds up to price support for gold. As one European analyst puts it, in the context of global negative interest rates, “Gold is increasingly attractive in this environment. It used to be said that gold doesn’t pay interest, now it can be said gold doesn’t cost interest”.
Goldman Sachs, Macquarie and many others have now lifted their gold “price decks”, meaning their forecast average prices for 2016, 2017 and beyond. But this is not a reason for holders of gold to salivate. For many analysts, such upgrades represent a swing from prior expectation of a weaker gold price due to Fed rate hike expectations.
Goldman’s three-year USD gold price forecast is now 1300. At the time of writing, gold is trading at US$1313. Goldman’s 2018 average price forecast is US$1250, up from US$1150. Macquarie has gold averaging US$1300 in mid-2018. Many of these gold forecast upgrades are more catch-up than anything else.
There are nevertheless others forecasting gold to surpass US$2000/oz by 2018, which, let’s face it, is a long time away.
While falling global bond yields are supportive of more strength in gold, in the shorter term gold’s movement will be more about the “fear trade”. It all depends on what transpires. UBS suggests investors should watch for how negotiations between Britain and the EU play out, whether they are amicable or confrontational, changes in support for anti-establishment movements across Europe, and whether the EU will move towards closer integration or towards disintegration over time.
“We believe these factors are likely to drive retail physical gold buying in Europe,” says UBS, “and it will be interesting to see if there are signs of this in the coming days”.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
