The death of gold... again!
23 September 2022
Dear Investor,
In this week's market update:
Precious metals stable as US Federal Reserve delivers 0.75% rate hike
Policymakers worldwide continue rate hiking spree, with the Riksbank in Sweden surprising markets with a full percentage point increase
Markets remain fragile, with US equities down 4% in past week
Bond yields soar as 2-year yields climbs to highest level in 15 years
Depressed sentiment toward precious metals could mark turning point for the sector
What does the data tell us?
Interest rate increases have dominated financial market headlines and investor positioning this past week, as central banks around the world continued their policy tightening path.
The chart below, produced by Deutsche Bank earlier, highlights the full list of central banks that were set to make monetary policy updates this week, and what expectations for each bank were going into their meetings.
The Riksbank in Sweden were the first to meet, and it’s fair to say they shocked markets by implementing a full 1% interest rate hike (vs. expectations for a 0.75% increase).
In explaining their decision, the Stockholm based central bank used language that could in essence be replicated across the globe, noting that; “Inflation is too high. It is undermining households’ purchasing power and making it more difficult for both companies and households to plan their finances”
Since the above chart was published, most of the central banks named in the above chart have tightened policy in line with expectations, with the other standouts being the Bank of Indonesia, who exceeded expectations with a 0.50% hike, while the Bank of Turkey went the other way, cutting rates from 13% to 12% despite current inflation rates of more than 80%.
The highest profile of these was of course the United States Federal Reserve (the Fed), who, as per market expectations, hiked rates by another 0.75% at their policy meeting on the 21st of September, with the Federal Funds rate now sitting at a target range of 3-3.25% in the United States.
Perhaps more importantly, expectations on the future path of monetary policy have continued to tighten, with the Fed now indicating rates could rise to 4.4% by the end of the 2022, and they are highly unlikely to reverse course and cut rates anytime soon, even if the economy softens.
Market reactions to the policy decision we’ve seen enacted this week have been mixed. Equities have remained fragile, with the S&P 500 -4% over the last five trading days, while cryptocurrencies are still struggling to find a bid, with Bitcoin still trading below USD $20,000.
The US dollar, which we discuss in detail below, has continued to move higher, with the dollar index (DXY), now trading above 111, up 1% on the week, and almost 20% on a rolling 12-month basis.
Yields have also continued to rise, with 2-year US treasuries now trading 4%, their highest level in 15 years, while 10-year bonds have spiked another 0.25% this week (to 3.70%), with much of the move coming overnight, after the Bank of Japan announced they are intervening in the currency market to strengthen the YEN. The real yield on the 10-year, which factors in expected inflation over the next decade, is now sitting at 1.30%, up 0.50% since the start of September.
Given these market movements, and the multiple headwinds that could have pushed both gold and silver lower, precious metal investors should if anything be encouraged by their recent stability and resilience.
By and large that’s not the case though, with sentiment continuing to sour, as we discuss below.
Precious metals are unloved
Earlier in the week, no less than the Wall Street Journal ran an article titled “Gold Loses Status as Haven” (see image below), which noted that the precious metal had fallen by circa 8% for the year.
We have little issue with much of the content in the article itself, for it makes some relevant points as to why gold has not fared as well as many would have hoped given the surge in inflation we are currently seeing, referencing the strength in the US Dollar, surging nominal bond yields, large outflow from gold ETFs, and the uncertainty caused by the Fed’s rapid tightening of monetary policy.
Rather we are more interested in the tone of the recently published article, the headline itself, and the timing of its release. In no small way, they remind us of a mid-2015 article, also published in the Wall Street Journal, titled: “Lets be honest about gold: It’s a pet rock”. That article, which is just over seven years old now, was more than a little scathing about the merits of investing in precious metals.
Articles of such nature are typically only published when sentiment toward gold (or any asset class for that matter) is at rock bottom levels, like it is today, which often end up being great buying opportunities.
As a result, rather than heralding the death of gold, negative headlines such as the one seen in the Wall Street Journal this week often mark the birth of a bullish phase for the precious metal.
Indeed, the gold price in USD terms is up by more than 50% (and just over 65% in AUD terms) since that July 2015 gold is a pet rock article was published.
There are no guarantees, but it wouldn’t shock to see a similar outcome this time around.
King dollar and the uninvestable Euro
There is little doubt that the strength in the US Dollar (USD) has been the dominant force in financial markets this year.
The Dollar Index (DXY), which measures the performance of the USD vs. a basket of other developed currencies that includes the Euro, the Japanese Yen and the British Pound, is having one of its best years on record, rallying by almost 15% in 2022.
So strong has the dollar been that many currencies are now trading at multi-decade lows relative to the USD, including the Euro, which as per the chart below, is now trading more or less at parity with the USD.
The Euro has lost almost 40% of its value since the levels seen 2008 during the Global Financial Crisis (GFC).
The Euro has performed so poorly of late, and the continent faces so many serious problems (energy security being just one) that some market commentators are now calling the Euro uninvestable.
Investors by and large seem to agree, with allocations to European equities now sitting at record lows, as illustrated in the below chart, which is based on a recent Bank of America Fund Manager Survey.
Years ago, a market commentator famously quipped that; “you make the most money when things go from truly awful to merely bad”.
Without in anyway wishing to diminish the challenges that Europe does face, charts like the one above suggest that markets may have already priced in a truly awful outcome.
It won’t take much for investors to become relatively (and we stress relatively) more optimistic toward the Euro, and less obsessed with the USD. If that happens, it will almost certainly support gold, and the broader precious metal complex.
How important is the dollar to gold anyway?
While gold prices will most likely get a lift if the USD starts to weaken, its far to simple to see gold as an anti-dollar play, and one that can only thrive in periods the USD is weakening. The two assets can often rise in tandem, as we explored in some detail in a blog posted earlier this week.
Indeed, since the end of 2015, the gold price has risen by more than 55% in USD terms, despite the fact the USD index is up by almost 15% over the same time period.
For local investors, there are also movements in the AUDUSD FX rate to factor in. If the USD is rising vs the AUD by more than its rising vs gold in any given period, then the performance of gold in AUD could be positive, even if the news headlines are lamenting the fall in USD gold prices.
Indeed, if we look at the last year, that’s exactly what has happened, with USD gold -6%, while AUD gold is +3%, with the difference driven by the 8% fall in the AUDUSD FX rate over this period.
Warm regards,