Gold and copper divergence yawns wider
Head of Commodity Strategy
Summary: With sentiment towards risk assets continuing to be underpinned by vaccine optimism, we are seeing a continued divergence between commodities depending on economic growth and those offering protection against uncertainty. These developments have been very visible especially across the metal sector where copper has surged to a seven-year high while gold has slumped back below $1800/oz.
The November 9 vaccine announcement from Pfizer/BioNTech that was followed by others, continue to be one of the key dates and announcements impacting the commodity sector ahead of December and yearend. Commodities such as industrial metals and crude oil prices have rallied strongly on increased optimism that the a vaccine will ensure the spreading of an ongoing economic recovery that is already under way in Asia. Gold and silver meanwhile has declined with investors swapping into riskier assets in order to profit from the expected recovery theme.
While HG copper has reached the highest level in seven years, gold has now declined by 14% since the August peak from $2063/oz. On Friday, during a 60 minute window in a relative thin Thanksgiving holiday market, the price slumped below $1800/oz with close to 60,000 lots (6 million ounces) swapping hands in the COMEX gold futures contract.
Gold’s spectacular rally to a record high this year helped drive a large amount of investment demand from investors seeking diversification amid a surge in fiscal and monetary spending driving reflationary concerns. Despite peaking in August, demand for exchange-traded funds backed by bullion continued to climb until mid-October when total holdings peaked at 3450 tons. Since then and especially since November 9 total holdings have declined by nearly 100 tons to a four-month low.
Back in January and before other markets realized what the world was about to face, Dr. Copper was the first market to send out a signal of distress as the Covid-19 emerged in China. However with China being the first major economy to recover from the impact, copper, given its near 50% dependency of Chinese demand has witnessed a very impressive 65% bounce back from the March low.
Apart from the current strong momentum driving increased speculative investment demand both in and outside China, the fundamental reasons behind the rally to a seven-year high has been explained by strong Chinese physical demand, supply disruptions from virus hit mining operations in South America. Most recently, however it has been the prospects for a vaccine increasing demand outside of China through increased fiscal spending and investments in the green transformation, especially electrification driving strong demand for the red metal.
Just how much the sentiment has changed within the past six months can be seen in the gold / HG copper ratio. After hitting a record high back in April when market conditions were the worst, copper’s relative outperformance since then has been equally impressive with the ratio slumping to a 16-month low.
Gold’s recent weakness, especially during the past week, has occurred a time where the Bloomberg Dollar Index has slumped to a 20-month low while U.S. ten-year real yields have showed renewed signs of weakness. Despite these two normal tail-winds for gold and silver, the market has instead concluded that the rolling out of a vaccine would require less tail-end protection.
We are fundamentally opposed to this conclusion as the prospect for a weaker dollar and low to lower real yields – not higher – eventually will provide fresh support. Apart from the current phase of long liquidation, as some investors are forced to adjust exposure, gold analysts currently differ in their opinion with regard to the direction and during the past few weeks some banks have lowered their overweight in gold siting rising real yields as a negative development for gold.
We see a risk of rising nominal bond yields with a potential break on U.S. ten-year notes above 1% driving it higher towards 1.5%. However we maintain the view that rising nominal real yields will be driven by rising breakevens (inflation expectations) and not so much rising real yields. They are most likely to going to remain anchored around the current -1%.
Looking at the underlying sources of demand for gold, investment demand may suffer a further short term setback, but against this the recovery in economic and social activity may see a revival in jewellery demand, not least from China and India, the world’s biggest consumers. Pent up demand from a sector which during the past five years accounted for 50% of total demand (Source: World Gold Council) may be lurking following a 40% yoy slump in Q1-Q3 this year.Having slumped below $1850/oz and now also the 200-day moving average at $1800/oz, gold’s short-term outlook remains challenged with the next level of support being $1763/oz, the 50% retracement of the March to August surge and the top of third quarter consolidation range.