Gold Market Commentary

Strong earnings but sentiment is waning and COVID is once again coming to the fore

Many major companies reported Q2 earnings during the month and many surpassed already lofty expectations. However, recent research suggests investors have become “much less bullish” on global growth and company profits dropping from 91% in March to 47% this month.⁶ Much of this is driven by the belief that most of the post-pandemic economic boom is somewhat “baked into” current prices. Additionally, we’ve seen the COVID Delta variant shoot cases up across the world, causing new lockdowns and restrictions in some places. This could cause the economic expansion to slow as well.

Many economists and strategists believe that, as the market shifts cyclically, investment return expectations will be much lower – a quality that improves gold’s relative attractiveness.

In fact, for only the second time in 75 years, the S&P 500’s real yield has fallen into negative territory; this is represented by companies’ earnings yield (or the opposite of P/E), plus the dividend yield earned from the companies, minus inflation. The last time this occurred was in 1946  (Chart 2).

Some central banks are sending mixed signals

The US Federal Reserve held its conference at the end of the month and left many investors with some confusion regarding future action. The story for months has been inflation and whether it will be “transitory” or not. Inflation is a positive for gold, and whether or not the recent spike is short-lived via the specific CPI methodology, there is a clear indication across other metrics that inflation is likely here to stay. The ECB also made a recent shift in its strategy to allow it to “overshoot” its target inflation levels.

Although the Fed discussed inflation many times, the focus appeared to be drawn toward full employment. Chairman Powell used the term “substantial further progress” to describe what is necessary for full employment, with less emphasis on inflation. Simply put, it appears the Fed’s future decisions are going to be more related to the labour markets than ever-increasing inflation numbers. This propelled gold higher as it signalled to the market that any change in policy could be drawn out even further than current expectations suggest, i.e., lower rates for longer with more time for inflation to build – both of which are good for gold.

Despite the significant interim GDP expectation for growth in the US, Q2 GDP came in at 6.5%, versus the forecast of 8.5%. This is somewhat troublesome given that some economists believe these numbers will fall below 2% in the coming quarters. The lower Q2 results can be largely related to the unexpected drop in inventories, a byproduct of consumer spending, which was a significant driver of overall demand. Consumer spending is certainly a significant driver of the strong bar and coin demand for gold. 

ETF Commentary: Gold ETFs added US$670mn (11.1t) to global assets under management (AUM) in July, adding to slight inflows in June (Table 1 and Chart 15). Global AUM stood at US$214bn (3,636t) at the end of the month, still more than 10% shy of the August 2020 high of US$240bn and 7% of the October 2020 tonnage high of 3,909t. We believe these inflows were largely a function of heightened investment demand in Europe due to the recovering gold price and continued interest in low-cost ETFs, strengthened by renewed inflation concerns and record low real yields. Read our full July gold ETF flow commentary on Goldhub.

Table 1: Regional changes in gold-backed ETF holdings*

Looking ahead: September is a historically positive month for gold returns

Investors often use seasonal patterns to find opportune entry and exit levels. This tends to hold true for gold on average, over time. Historical analysis suggests that after a statistically positive performance during January, gold returns tend to be mixed with no consistent pattern linked to seasonality but driven instead by underlying macroeconomic variables. That tends to change again towards the end of Q3 when various market forces align resulting in a historically strong period for gold. 

Our analysis shows that gold has historically delivered positive returns during September with a confidence level just shy of 90% (Chart 3). This is likely driven by a combination of two trends: a period of strong demand linked to the Indian wedding season and other festivals in October and early November, and higher global investment activity following typically quieter summer months. As such, investors have often used August as an opportune time to add gold to their portfolios.

In addition, Qaurum^SM, our web-based valuation tool, suggests that there could still be upside for gold during 2021 based on various hypothetical macroeconomic scenarios.⁷

In our view, the central bank terms of “transitory” or “persistent” inflation and “full employment” will remain key areas of focus for investors and policy makers. Especially since diverging perspectives will influence market performance and level of interest rates.

While gold’s performance may not have countered the recent fall in yields, it could do so as investors position for a historically strong September. And if the Fed holds true to its recent comments and focuses more on employment, we could see recent levels of high inflation become more persistent. During these periods gold has historically outperformed its long-term average, increasing by an average of 15% in years where US CPI has been higher than 3%. In addition, surging cases of COVID could also slow down the global economic recovery, which may hinder gold jewellery consumption but may also result in strong flight-to-quality flows for gold investment as it did during 2020.

Regional insights

China: In July, the physical gold contract at the Shanghai Gold Exchange (SGE) averaged a trading volume of 9,755t, 31% lower than June, suggesting weaker physical gold demand in the month. July is traditionally the offseason for gold consumption in China because:

• there are fewer outdoor activities as July is one of the hottest months in China
• consumers prefer lighter jewellery products in summer

The typhoon and flood in central China and outbreaks of COVID-19 in key regions also weighed on demand.⁸

Chinese gold ETFs had a 1t inflow in July. Extending June’s strength, Chinese gold ETFs continue to draw attention likely driven by:

• higher safe-haven demand amid a weak equity market as the CSI300 stock index fell 7.9% in July, its worst month since October 2018
• the local gold price, which bottomed late June and has been rallying in July, prompting investors – attracted by the momentum – to increase their gold ETF allocation or enter the market in anticipation of further price gains (Chart 4)

The local gold price spread turned negative in June amid the difference in Chinese and western investors’ risk appetite, the expectation of tighter regulations, and recent sharp rises in gold imports. But as we discussed in our previous blog, these impacts tend to be short-term as China’s gold demand – the principal driver of the local gold price spread – remained relatively stable in June. And as the short-term impacts fade, the Shanghai-London gold price spread returned to positive territory. But the average spread in July was well below its average in the first half of the year as China’s physical gold demand weakens. 

According to China Customs, the country imported 68t of gold in June, flat m-o-m and 61t higher y-o-y. It was also 12t higher than June 2019 (Chart 5). This brings Q2’s total gold imports to 247t, 232t higher y-o-y and only 40t lower than Q2 2019. Even though the Shanghai-London gold price spread turned negative in June, it failed to impact China’s gold imports, suggesting that the negative spread was not driven by significantly weakened gold demand in China as we explained in our blog.  

India: Anecdotal evidence suggests that gold demand has remained moderately strong in the first half of July, predominantly for wedding purchases. However, the expectation was that demand would fizzle out from mid-month onwards in the absence of further wedding dates and with the approach of Aadi month in Tamil Nadu.⁹

The local market flipped back into premium in the first week of July, led by the recovery in retail demand and some restocking from retailers in expectation of a higher international gold price. The local market remained in premium of US$1-1.5/oz for the first two weeks of the month before the price jump disrupted the recovery in demand and pushed the local market into a discount of US$4-5/oz during the third week (Chart 6).

Europe: The change in ECB strategy was by far the biggest news this month. But divisions remain within the ECB on policy direction. Eurozone business activity has expanded at the fastest rate for 21 years. The UK lifted COVID restrictions, despite cases being on the rise. And serious issues over the Northern Ireland protocol (part of the Brexit agreement) and EU Green Deal remain at the fore, as European equities remain strong.

US: While ETF flows in the US have been largely predicated on gold prices – moving in tandem, but with a slight lag, bar and coin demand remain incredibly strong. The total demand through the first half of the year, already totals the full-year amounts for the previous three years as investors have used increased disposable incomes, in some cases, via stimulus cheques, to make purchases. This is also a function of the newly released gold Eagle coin, marking the 35th anniversary of the American Eagle Coin Program. So far, the Mint has reported significant sales since the launch.

Central banks upped their gold purchases in the second quarter

Central banks closed out the first half of the year purchasing 39% more gold than the five-year H1 average, with the lion’s share being purchased in recent months (Chart 7). Thailand, Turkey, Brazil, Poland, Kazakhstan, India, and the UAE were notable buyers. We discuss this in more depth in our H1 GDT report.

We believe this trend could continue; anecdotal evidence suggests several central banks plan to increase holdings in the future, as indicated in our 2021 Central Bank Survey.

Most asked investor questions

Here are our thoughts on the key questions we have received from investors during the past month:

Why has gold not reacted more positively with the most recent pullback in yields?

We’ve discussed the relationship between gold and rates at length in our report:  Investment Update: Rates pose risks but also unlock opportunities for gold. While it is easy to pick a point in time – such as June and July - and question the lack of movement in the gold price, while rates fell near the y-t-d lows, we need to provide context over a longer period. The last time the US 10-year, for instance, was at 1.20% - in February of this year - the price of gold was around US$1,800/oz. While rates spiked meaningfully from February to May, as global economies fared better and the potential for tapering begun, the price of gold held above the US$1,700 level, and at one point rallied back to US$1,900/oz, above where it traded when rates were at 1.2%. Our short-term model highlights that while rates have been an important driver of gold performance, inflation expectations have helped it hold up, as has positive momentum. And ironically, the price of gold now sits around US$1,800/oz, while the 10-year is near 1.20%, effectively where they both traded in early February.

Is the Fed’s most recent decision and meeting a sign of a longer period of inaction?

As inflation expectations rose in the second quarter, the Fed dot plot suggested that the market was pricing in at least one rate hike before the end of 2022.¹¹ With the resurgence in COVID cases, and its most recent language, the Fed’s probability of a rate hike by the end of 2022 is now only slightly better than a coin-flip at 58%.¹² As mentioned above, the emphasis on full employment appears to be a priority, and from that perspective, we are much further away from the sub-4% levels we saw before the pandemic began. With many government subsidies ending in the coming months, it is possible that many unemployed workers who were not actively looking for employment will be forced to do so and add to the percentage of those who are unemployed.

What has been the relationship between gold and cryptos lately?

One common assertion by cryptocurrency proponents is that bitcoin could replace gold as the ultimate store of value. Several of our reports discuss the fundamental differences between gold and cryptocurrencies. But other market experts have recently asserted their opinions on this theory and the overall correlation between the two assets. 

In our recent Gold Demand Trends webinar, one the participants expressed their doubts over this assertion, stating that cryptocurrencies – bitcoin in particular – and gold are “inversely correlated” because cryptos tend to behave like risk-on assets while gold as a risk-off asset.

We put this idea to the test by looking at the beta between equities – the traditional risk-on asset – and both bitcoin and gold.¹³ In addition, we measured betas across the spectrum of returns from positive to negative divided into percentiles. Chart 10 details that over the past five years using daily returns, gold’s equity beta has been effectively zero, but more importantly when gold returns have been low, this correlation hasn’t changed much. In other words, the worrying lower tail correlation we observe among risk-on assets isn’t present for gold. On the other hand, bitcoin’s beta to equities has been positive and rising in the lower tail, which is much more emblematic of a risk-on asset.

How has the gold market evolved during the 50-years since the end of the Gold Standard?

This month marks the 50th anniversary of the end of the gold standard in the US after President Richard Nixon unpegged the US dollar from gold allowing it to float freely in August 1971. Since then, the returns of gold have averaged 10% annually, up 50x from its 1971 prices.

While allowing the price of gold to float has encouraged globalisation and strong liquidity in the gold market, it has also enabled countries to increase debt loads immensely. Prior to 1971, US Federal debt, for instance, was around half of GDP, and has exploded in recent years to well over 100%, as low rates and easy money have encouraged speculative investing. But this has come with concerns of higher future inflation expectations, inabilities to repay the debt, and loftier market valuations where we have seen more frequent and prominent market selloffs.

While a return to the gold standard is unlikely, it’s worth noting that gold has been a true store of value over the past 50 years against fiat currencies that, for the most part, have devalued well over 90% during that period (Chart 11). And as global debt levels increase and inflation expectations continue, gold will continue to be there to provide returns and value over the next 50 years and beyond - as it has for over 5,000 years.¹⁴
 

Gold market monitor

Figure 1: Gold return in key currencies during 2021*

¹Based on the LBMA Gold Price PM in USD as of 31 July 2021.

²Based on the 12-month trailing earnings of the S&P 500, minus US CPI, plus the current dividend rate of the S&P 500 as of 31 July 2021.

³Based on the LBMA Gold Price PM in USD as of 30 June 2021.

⁴The US dollar average price based on the LBMA Gold Price PM as of 30 June 2021 is $1,805/oz.

⁵The Commitment of Traders (COT) report provides information on the positioning of speculative investors in the US futures markets: short positioning reflects bearish sentiment while long positioning reflects bullish sentiment in the gold futures’ markets. On Goldhub, see: COMEX net long positioning

⁶Investors turn ‘much less bullish’ on global growth and profits, FT, 13 July 2021. t

⁷Based on Oxford Economics scenarios published in Q2 2021 and calculations using the Gold Valuation Framework methodology available through Qaurum. A detailed description of these scenarios and their implications can be found at Goldhub.com. The World Gold Council does not forecast the price of gold. GVF is a methodology that allows investors to understand how gold’s demand and supply may react to various macroeconomic variables, based on historical relationships. Our web-based tool, Qaurum, is customisable and users can modify any of the variables included on the available hypothetical scenarios to best reflect their own view on the global economy. See important information and other disclosures at the end of this document.

⁸For more information, please visit: China flooding: Death toll rises in Henan as passengers recount horror of Zhengzhou subway floods - CNN China Focus: Delta variant identified in Nanjing's COVID-19 clusters - Xinhua | English.news.cn (xinhuanet.com)

⁹Aadi month starts from 17 July and ends on 16 August in 2021. It is considered an inauspicious period for gold purchases by the local community in Tamil Nadu.

¹⁰This data reflects changes in gross gold reserves. Since 2011, gold has been added to Turkey’s balance sheet because of gold policies aimed at supporting the banking system’s liquidity management. Please see the link for information https://www.gold.org/download/file/16208/Central-bank-stats-methodology-technical-adjustments.pdf

¹¹As of 30 June 2021.

¹²As of 31 July 2021

¹³“Beta”, also known as market sensitivity, refers to the regression coefficient between a financial asset and the a broad-based equity market index.

¹⁴The History of Gold, National Mining Association. www.nma.org/pdf/gold/gold_history.pdf