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Equity outlook: The high cost of global fragmentation for US portfolios
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Gold finding support despite surging yields
Ole Hansen
Head of Commodity Strategy
Summary: Gold prices, in a relatively steep decline for the past month, are showing signs of stabilizing after finding support around $1885. A development which is interesting as its unfolding while 10-year US Treasury yields have surged to a 16-year high on speculation the FOMC may have to hike rates further, and keep them higher for longer, as incoming economic data points to continued price pressure. Instead of yields the attention, for now at least, seems to focusing on a softer dollar, the Fed chairs speech at Jackson Hole on Friday and the BRICS meeting starting today.
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Gold prices, in a relatively steep decline for the past month, are showing signs of stabilizing after finding support around $1885. The five percent loss seen following the failed attempt to challenge $2000 last month has occurred during a period where the dollar has gained more than 2% while US 10-year Treasury yields have surged higher by 50 basis points to a 16-year high and speculation the FOMC may have to hike rates further, and keep them higher for longer, as incoming economic data points to continued price pressure.
While this remains the focus, asset managers and other potential investors may have their focus elsewhere amid the current high opportunity/funding cost for holding gold relative to short-term money market products. The cost of carry or opportunity cost in holding a gold position is equal to storage cost and the interest income an investor otherwise can receive on a short-term interest rate instrument like T-bills or a money market product. So, whether you own physical gold or hold and roll a futures position, there is no escape from the fact that it carries a cost, either through not receiving the +5% through a short-term interest rate instrument or through the roll into a higher priced forward price in the futures market.
These ongoing developments is reflected through the continued reduction in ETF holdings backed by bullion while the recent loss of momentum has driven a 65% four-week reduction in the net long held by hedge funds in the futures market. In the last two Commitment of Traders reporting weeks to Aug 15, the gross futures short held by these traders jumped 38k and based on the volume weighted average price (VWAP), the pain level is somewhere around $1935 in spot and $1965 in futures, so plenty of work to do before short covering becomes a feature. ETF investors meanwhile have been reducing their gold exposure on an almost daily basis since late May, during which time total holdings have declined by 128 tons to a 3-1/2-year low at 2800 tons.
However, despite these major headwinds not least surging real yields, gold is showing signs of stabilizing with the recent bid being supported by a softer dollar and rising silver prices amid higher industrial metal prices on continued speculation China will have to do more stimulus. In addition, investors may also be contemplating the risk of Powell doing a 180 in his speech on Friday at Jackson Hole, basically saying the Fed is done. While it's very unlikely the risk of such a move could be enough to sway a few short positions.
BRICS summit kicks off today
It is also worth mentioning the BRICS meeting, starting today, with Brazil, Russia, India, China and South Africa. The agenda is expected to center around the group’s expansion, with some 40 other nations lining up to join including Indonesia, Saudi Arabia, Argentina and Egypt. This could mean internal conflict as South Africa seems open to the idea, but Brazil is worried about its influence getting diluted. Meanwhile, Russia is attempting to ward off currency pressures at home and Xi is trying to find the most appropriate response to pressures on China’s property sector and economy at large.
But a larger group could mean more opposition to the West and a larger pursuit against the dominance of the dollar. This could, however, be positive for gold which acts as an alternate store of value and central banks continue to ramp up gold purchases in order to hedge against the dollar. Ahead of today’s meeting there has been increased talk of the BRICS nations developing a new reserved currency, potentially backed by gold, that could rival the US dollar as the global reserve standard. Many countries are seeking greater independence from the US financial system in response to continued weaponization of the dollar in the form of sanctions and trade wars.
With the dollar currently being used in 84% of cross-border trade, the potential for a successful alternative remains very low, and with that in mind gold remains the best option for central banks in need of reducing their exposure to hard currencies like the dollar, and such demand will likely continue to provide a soft floor underneath the gold market.
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