Gold's misfortune remains tied to the dollar

Ole Hansen

Head of Commodity Strategy, Saxo Bank Group

Gold remains under pressure from the stronger dollar and emerging market weakness, something that was highlighted Monday when the collapse in the Turkish lira triggered across the board gains for the dollar while sending gold through support at $1,205/oz. The market is currently transfixed by the negative impact on those EM economies with large external debt in dollars at a time where both the dollar and funding costs are rising.  

Instead of providing support to gold, these geopolitical problems have instead helped send the metal even lower. Currently it is trading close to a trendline that can be drawn all the way back to 2008.   

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Source: Saxo Bank

Longer-term investors trading exchange-traded funds backed by gold and hedge funds operating in the futures market have all been sellers in recent weeks. While total holdings in gold ETFs since May have dropped by 5% or 112 tons to the lowest since January, hedge funds have taken their net-short in Comex gold futures to a record short. 

In the week to August 7 gold’s net-short reached a new record of 63,000 lots as funds continued to add length to the gross-short while cutting gross-longs.

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The ongoing trade war between the US and China, which is showing no signs of being solved anytime soon, has helped trigger a 10% drop in the value of the Chinese yuan since April. During this time gold has fallen by 12% and as a result we have seen gold trade relatively stable against the yuan. This is unlikely to be a coincidence and while we are still searching for the exact reason for this strong correlation, some speculation has started to emerge that some traders are using gold as a proxy to short the yuan through easily available and easily shortable gold.

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Source: Saxo Bank
While the People's Bank of China has stepped in and raised the cost of shorting the yuan, traders have instead – in light of the current high correlation – chosen gold as their go-to product. Recent economic data out of China have already shown signs of weakness and with the trade war continuing the speculation is that China will allow its currency to weaken further to shield its exporters from the rising tariffs being imposed by the US. 

Correlations come and go and if we look back just a few months to May, the two instruments with the highest correlations to gold were the Japanese yen at 0.79 (now 0.29) and US 10-year real yields at 0.60 (now just 0.06). 

The high correlation is likely to continue either until the dollar begins to weaken or the trade war is halted or escalated to the point where bond yields and stocks turn sharply lower. 
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Source: Bloomberg

Technical indicators such as RSI show that the metals, both precious and industrials, have moved into oversold territory. With that, the risk of a sharp correction continues to rise.

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