Gold remains troubled but headwinds unlikely to persist

Gold has now been through a 15% top to bottom sell-off before - at least for now - once again finding support at $1450/oz. The correction has obviously once again raised the question of whether gold is worth it’s tag as a safe-haven and diversifier. We believe the long term reasons for holding gold has if anything been strengthened by current developments.

While official interest rates have been slashed,  corporate bond yields have been rising. The broken transmission between central bank actions and developments on the ground is likely to trigger a major fiscal and potential inflationary response from governments around the world. US 10-year real yields, another major driver of gold has risen sharply during the past week in response to much lower inflation expectations. We believe these direction is unsustainable and that real yields eventually will move back into a deeper negative territory (see chart below).

The sell-off has also been amplified by the aggressive sell-off in crude oil. The Russian central bank has been a strong buyer of gold in recent years. That buying has now stopped and depending on how long it will take before crude oil recover we could potentially see Russia become a net-seller. This in order to cover the shortfall after the price of oil slumped below their budge breakeven which is somewhere close to $40/b.

However, as mentioned, the main driver behind gold’s recent weakness has been the “dash for cash”. A move that was strengthened by the elevated leveraged positions that had been built up in gold during the past few months. In my latest COT report covering the week to March 10 I highlighted how deleveraging had become the overriding theme with both long and short positions being reduced. The biggest long reductions were seen in crude oil, gold, sugar, cocoa and cotton while short-covering was seen in natural gas, soybeans and corn.

The open interest in COMEX gold futures has dropped to 573,00 lots, the lowest since last July. A sign that positions, both long and short have now seen a significant reduction from the January peak at 800,000 lots.

The difficulty in fully understanding the sudden weakness and temporary loss of safe haven status have raised some concerns that the link between cash and paper is under pressure. While paper gold has seen a significant amount of selling the cash market has reacted to developments across the different regions. Discounts have been offered in Asia and India while dealers in Dubai have noticed a premium in recent days. Overall we conclude that the Covid19 has triggered a significant disruption to supply chains and logistics. Major buyers have temporary close down their borders while others have witnessed a slump in demand. Against these developments the supply chain is also severely stressed with shipments being held back and not reaching their destination, in this case Dubai.