Since mid-July, bullish bets on Gold started to resemble mania or hasty shift to safe haven in anticipation of some disaster. The rally seemed well-founded, but more recently, an irrational buying spree was also felt. For example, from July 17 to August 6, only one daily candle was down and the past high from 2013 (~ $ 1920) was overcome relatively easily.
Gold crossing through $ 2000 level at ease created impression that it targets $ 2,500, $ 3,000 and even $ 4,000 per troy ounce. Bearing that in mind, it was difficult to trade countertrend. For the same reason, it was difficult to estimate the level from which correction would begin. Now, after the pullback has occurred, we have the opportunity to discuss whether it is an interim correction or the signal of global U-turn which in my view is a better trading opportunity.
Among potential factors explaining 5% downside move in gold was a surge in Treasury yields (direct rivals of Gold in investment portfolios), increased optimism related to the development of Covid-19 vaccine, economic news, new details on the US fiscal deal, etc. Let’s go through the points.
The yield on 10-year bonds hit 0.5% on August 6, from which it began to rise and reached 0.67% on Wednesday. Around the same moment, the decline in gold began which suggests that gold’s decline is related to Treasuries’ move. However, as we can see from recent history, there were larger in amplitude fluctuations in treasury yields which caused smaller decline in gold:
It is fair to say that the liquidation of gold positions in March was also exacerbated by liquidity crunch. But if we consider June spike in yields which is larger than current one, gold’s reaction was relatively muted.
We can look at the connection between gold and the Treasury market from a slightly different angle. Gold has high correlation with TIPS (inflation-indexed Treasury bonds) – both are hedges against inflation, only for different time horizons. So, if we assume that some shift in inflation expectations was a factor in the correction, then TIPS should have corrected as well – however, the move in TIPS yield was much weaker:
It turns out that with such a sluggish move in the “peer” asset, the fall in gold can be explained either by the fact that mainly long-term inflation expectations were sharply revised or a shift in inflationary expectations was not the main explanatory factor.
There are absolutely no signs of U-turn in Fed’s accommodative policy, since the Central Bank made it clear that until 2022 there won’t be any steps towards normalization (famous “we don’t even think about thinking of raising rates”) and if there will be changes, then only in the direction of further policy easing & balance sheet expansion.
On August 7, the NFP was released, which posted modest surprise in jobs count however, the effect of the report on the market quickly fizzled out. It’s unlikely that jobs report could cause some profound shift in expectations.
As a result, one likely explanation of the sharp decline in gold is a technical correction (profit taking move) which, taking into account gold’s position at historical peak, turned into avalanche of sales, exacerbated by momentum selling from algos. Fundamentally, expectations for Gold remain the same, since as we can see, key factors of the rally remain in place.
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