Head of Commodity Strategy
Summary: Gold and silver, as well as copper, have suffered continued losses in response to central bank rhetoric, most importantly from the US Federal Reserve regarding their resolve to bring down runaway inflation through aggressive rate hikes. Silver meanwhile has slumped to a two-year low as its close correlation with industrial metals, most notably copper, continues. This sector has seen additional pressure in response to China's continued and so far unsuccesful handling of Covid infections via growth killing lockdowns
Gold and silver, as well as copper, have suffered continued losses in response to central bank rhetoric, most importantly from the US Federal Reserve regarding their resolve to bring down runaway inflation through aggressive rate hikes. A development that continues to raise headwinds for investment metals through its impact on the dollar which has jumped 10% against a basket of major currencies this year, while US 10-year real yields have seen their biggest jump in decades, currently up 1.8% in 2022.
Demand for investment metals will likely remain challenged until we see the dollar and bond yields stabilizing, perhaps not until a deteriorating economic outlook forces a rethink or inflation fails to fall at the pace currently projected by the market. Since Federal Reserve Chairman Powell’s hawkish speech at Jackson Hole last Friday, forward inflation expectations have declined further with the inflation swaps out to five years now all pointing to inflation below 3%.
In a recent update, titled “Core inflation is unofficially dead” my colleague Peter Garnry highlighted why elevated food and energy prices will support higher than expected inflation for longer with climate change and the green transformation being inflationary in the years to come. A development that leads us to believe that in an inflationary environment the tangible world, which includes commodities, must increase dramatically, so investors should invest in the tangible world to offset the inflation risk in order to preserve wealth in real terms.
Gold’s ability to act as a diversifier has increasingly been called into question with the latest decline to near the key support area around $1680/oz. Once again, however, it is worth highlighting that gold, except for XAUUSD which has been troubled by the mentioned 10%-dollar rally, continues to do better than under pressure stocks and bonds. XAUEUR trades up 13% year-to-date compared with a 17% loss on EuroStoxx 50 index while the 6% loss in XAUUSD compares favorably with the 17% loss in the S&P 500 and 25% drop in long end bonds.
Looking ahead we see no reason to change our long-term bullish view on gold with support potentially coming from the risk of a policy mistake sending US economic growth, the dollar and bond yields lower. In addition, the physical market is likely to respond to lower prices by seeing a pickup in demand, while positions in the futures market held by speculators and in ETFs by long-term focused investors remain relatively light.
Total holdings in bullion-backed ETFs have by now declined 7.2 million ounces from the April peak to 99.9 million ounces, some 2.2 million ounces above the December low. Hedge funds, typically operating in the futures market due to its leverage nature, held a modest net long of 30k contracts or 3 million ouncesin the latest reporting week to August 23, some 75% below the five-year average. Additional negative price momentum could see the position switch to a net short for only the second time since April 2020, a development that lifts the possibility of a strong rebound once the technical and fundamental outlooks turn more favorable towards the investment metal sector.
Silver has seen the biggest decline, and at $17.70 it has reached a two-year low, down around 23% on the year. Silver has not only been challenged by the weakness mentioned in gold but also, and more importantly, by China weakness related selling across industrial metals, especially copper which trades down 22% on the year. The rout in silver and copper, as well as zinc and aluminum, two metals that recently found support from smelters reducing capacity due to high energy costs, has by now reached the capitulation stage with silver having entered a previous consolidation range between $16.50 and 18.50. Speculators, according to our weekly COT update, already hold net short positions in both metals, and it would require a change in the technical and/or fundamental outlook to turn those short positions into a tailwind through short covering.
The gold-silver ratio, last at 96 (ounces of silver per ounce of gold)has retraced more than 50% of the 2020 to 2021 collapse from 127 to 62 with the next level of resistance around 102.5, a potential further 6% underperformance relative to gold, while a break back below 94 would be the first signal of strength starting to come back.
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