Gold Breakout Gains Strength!

It’s been a strong month for precious metal bulls, with the price of gold rallying well above USD $1,300oz, up some 5% since the start of the August. Year to date, the metal is now up approximately 15%, a fantastic return in an environment where broader volatility has been subdued, and crypto-currency mania has dominated financial headlines.

Silver has also performed well, rising by almost 7% in the last month (+12% YTD) to trade just below USD $18oz at present, with the precious metal complex as a whole strongly outperforming risk assets over the past month.

This much is seen in the chart below, which plots August returns for a range of asset classes, commodities and FX markets.

The strength in precious metals over the last month or so can be put down to a multitude of factors, including;

• A fall in the value of the USD, with the Bloomberg dollar spot index continuing to decline and now down close to 10% for the year

• Stagnant if not declining equity markets

• Heightened concerns over the strength of the US economy, which will impact the ability of the Federal Reserve to raise interest rates

For evidence of that last point, consider the latest US payrolls data, released on Friday the 1st September. Going into the release, markets were expecting payroll growth of close to 180,000 jobs, and average hourly earnings growth of 2.6%. Results were weaker than expected, with payroll growth coming in at a disappointing 156,000 jobs, whilst hourly earnings and average hours worked also missed expectations.

On top of that, we also saw US construction spending decline by 0.6%, with year on year growth in this key indicator down to just 1.8%. As per the chart below, that's approaching the kind of levels that tend to suggest a recession is in the not too distant future.

Over the last 24 hours, gold’s safe haven status has also come into play following yet another escalation of tensions on the Korean peninsula, with the Hermit Kingdom reportedly conducting a hydrogen bomb test, much to the chagrin of the international community, not to mention the millions of people who live in South Korea and Japan in particular.

In terms of what happens next, there are a handful of factors suggesting gold could continue to push higher, with Bank of America Merrill Lynch seeing the yellow metal at USD $1,400oz by early 2018.

We could get there much sooner if things continue to deteriorate in Korea, as that would no doubt add volatility to global risk markets, and further push investors toward defensive safe haven assets like bullion.

Supporting the bullish thesis, we’ve been encouraged by the recent move in gold miners (both large and small caps), which are obviously a much higher risk way of gaining exposure to precious metal prices. ETFs tracking these markets were up 6-7% last week, with the performance of GDX and GDXJ over the past 18 months or so seen in the chart below.

Silver's outperformance over the past month is also a source of encouragement to precious metal bulls, with the Gold to Silver ratio (GSR) recently declining below 75:1.

In early August, the ratio was closer to 78:1, as the following chart indicates.

An environment where gold is rallying, but lagging the performance of silver and the precious metal miners on the upside is typically a positive one for bulls, and suggests that the momentum supporting this move may have further to run.

We are also seeing some buying support come in through the gold ETFs, with GLD adding approximately 40 tonnes of gold to its holdings in the last month, an indication that Western investor appetite for the yellow metal is returning.

One note of caution is warranted though, and that comes from looking at the behaviour of the hedge fund community, who have recently aggressively stepped up their buying of the yellow metal.

This buying has been a major factor helping propel gold close to USD $100oz higher in this latest rally, which began in earnest back in early July.

In terms of the scale of recent hedge fund buying, this article has the relevant details.

“The non-commercial futures contracts of gold futures, traded by large speculators and hedge funds, totaled a net position of 231,047 contracts in the data reported through Tuesday August 29th. This was a weekly gain of 22,609 contracts from the previous week which had a total of 208,438 net contracts.
 
The speculative bets have sharply gained for six straight weeks and by a total of +170,909 contracts over that time to the highest overall net position since October 4th of 2016 when net bullish bets totaled +245,508 contracts.”

The increase in speculative positioning is seen in the chart below (green area section), alongside the increase in commercial shorts (red area section), and the close price for GLD, an ETF that acts as a proxy for the gold price in the chart below.

As such, whilst we are still long-term very bullish the metals, a consolidation of recent gains should not be unexpected, and at the very least, we’d expect gold to face resistance closer to USD $1375oz, before pushing on to new highs in this cycle.

For Australian dollar investors, the other factor at play is of course the local currency, which at present is trading just below USD $0.80.

The recent run of economic data in Australia has pushed back our view of when the RBA will cut interest rates again, something we originally thought they’d do this year.

Over the medium term, we’re still convinced rates will have to go lower, and would not be surprised to see them head below 1% by 2018/2019. Some are even more bearish, with Longview Economics seeing the Aussie cash rate as low as 0.00% in the future, as per this article in LiveWire markets.

Given the market is currently predicting rate hikes by the end of next year, a dovish re-appraisal of the path of monetary policy in Australia will almost surely lead to a lower AUD, and much higher precious metal prices for local investors.

As such, buying on dips and maintaining a core long-term position in a portfolio remains the most appropriate course of action.

Warm Regards,
Jordan Eliseo

Disclaimer
This publication is for educational purposes only and should not be considered either general or personal advice. It does not consider any particular person’s investment objectives, financial situation or needs. Accordingly, no recommendation (expressed or implied) or other information contained in this report should be acted upon without the appropriateness of that information having regard to those factors. You should assess whether or not the information contained herein is appropriate to your individual financial circumstances and goals before making an investment decision, or seek the help the of a licensed financial adviser. Performance is historical, performance may vary, and past performance is not necessarily indicative of future performance. Any prices, quotes, or statistics included have been obtained from sources deemed to be reliable, but we do not guarantee their accuracy or completeness.