Bonds see ‘bad’, equities see ‘good’
Gold gained 3.1% in July to US$1,971 bringing the y-t-d return to 8.7% (Table 1). Global gold ETFs saw outflows of 32t, evenly distributed between Europe and North America. But 93t of mostly new longs pushed COMEX managed money net long positions to 362t (26% of open interest).
Our gold model GRAM suggests that risk factors were the primary drivers of gold’s gain, contributing 1.7% (Chart 1). Of these, a sharp rise in breakeven rates on the back of much stronger-than-expected economic data was key.1 But this move suggests a conundrum. Growth data has been stronger and inflation data has been weaker, yet the rise in breakevens was the result of stronger nominal yields – not real yields – suggesting the bond market sees ‘good’ data merely as inflationary rather than growth-inducing. This appears to be indicative of the rift between the equity market narrative of a soft landing and the bond market narrative (drawn from a record inverted yield curve) of an eventual hard landing.
A weaker US dollar also helped drive gold higher, adding 1.2% to the monthly return. Conversely, a jump in Treasury yields and ETF outflows held gold back.
Table 1: Gold rallied in all but one currency in July
Gold price and return in different periods across key currencies*
*Data to 31 July 2023. Based on the LBMA Gold Price PM in USD, expressed in local currencies.
Source: Bloomberg, ICE Benchmark Administration, World Gold Council
- January and August are historically the strongest months for gold returns
- August returns have likely been influenced by seasonally weak US Treasury yields, some wholesale buying in China and restocking in India, as well as anticipation of a seasonally weak September for equity returns
- On balance, the factors that typically drive a strong August for gold are likely to be absent this time round.
January and August are gold-friendly months
Last June we analysed monthly seasonality in gold returns. We found quite a material shift in seasonality since the 1970s, with the last 20 plus years showing stronger January and August averages, and the former also ticking the ‘statistically significant’ box.
January strength has also coincided with seasonal weakness in US inflation-linked bond (TIPS) yields (Chart 2) suggesting that portfolio rebalancing, an adjustment to inflation hedges, or simply a response to those weaker yields are factors that have helped drive gold returns higher than average at the start of the year.2
August strength has been less consistent, showing some statistical significance but with higher variation. Seasonal nominal Treasury yield weakness in August may provide some clues as investors may be looking for hedges ahead of equity weakness – and the accompanying higher volatility –in September (Chart 3).3
This appears to be confirmed by coincident seasonal weakness in consumer sentiment in August.4 In this context, gold’s safe-haven credentials may become more attractive as a result.
We also can’t rule out price support from festive and wedding-driven Indian buying as well as Chinese wholesaler restocking. But the seasonality trend in August for China isn’t that strong: while some choose to restock for the Chinese Valentine’s Day in late August - a traditional mini-sales boost - most jewellers replenish in September amid key industrial events and ahead of the anticipated National Day Holiday peak season in early October.5
A strong August this year is not guaranteed
There are good reasons why we may not experience a strong August this time round and they appear to outweigh the supportive factors.
- High local gold prices and a soft underlying economic environment in India and China suggest a lower appetite for physical gold buying during August
- Equity markets have managed to deflect weakening fundamentals, poor internals and high (retail) sentiment in H1, so they might arguably weather weak seasonals too, helped by a strong Q2 earnings season6. This may reduce the demand for hedges, partly explaining low implied volatility
- But, if investors do want to hedge, the low equity volatility environment has enabled them to acquire out-of-the-money puts at prices not seen since the Global Financial Crisis7, with a possible knock-on effect on hedging demand for gold
- Longer-term US Treasury yields are more likely to tick up than down in August given a more favourable inflation and growth outlook, potential repatriation of Japanese investment capital, and the US Treasury’s need to refill its coffers by up to US$1.3 trillion by year end.8 Firm nominal yields and rising real yields- as inflation drops -might curtail investment demand for gold (without triggering large scale disinvestment). But we have also found that August returns are significantly positive even when controlling for yields and the US dollar. This perhaps puts the onus on yields to have a rampant month to unseat gold from its seasonal trend.
- While longer maturity yields might rise, the Bank of Japan’s (BoJ) decision to relax its Yield Curve Control (YCC) policy could ignite yield volatility and push down the US dollar – although yield differentials between the US and Europe remain more important.9 The yen remains attractive given economic resurgence and a strong local equity market.10 A weaker US dollar and higher volatility are likely to support gold returns
- COMEX futures net longs are not extended and ETF outflows have been decelerating, leaving capacity for investment flows to increase on the right catalyst
- The risk of a second wave of inflation remains in the US economy, though perhaps not imminently. Forward looking indicators suggest that as real wages rise they could once again ignite prices. The NFIB small business survey of pricing plans, which closely tracks core PCE inflation has started to tick up, economic data is surprising on the upside, manufacturing PMIs are trending higher and single-family building permits reached their highest level in a year, suggesting that residential investment may have bottomed.11 High inflation environments have, historically, almost always come in waves.
August may not be as gold-friendly as it has been in the past , but there are good reasons as to why support for gold will establish itself later in the year. As discussed in our Mid-Year Outlook, upside looks more probable than downside for gold in the current environment. For example, while stocks have weathered plenty of headwinds so far with some emerging fundamental support, sentiment and valuation still appear elevated. Economic risks also remain firmly on the table, despite a sentiment shift over the last few weeks. The US debt ratings downgrade, alongside the announcement of a huge extension to government borrowing is the latest in a slew of datapoints that are indicating trouble ahead, including:
- Commercial and industrial loan demand
- Credit spreads
- Leading Economic Indicator
- US state and local income tax receipts
- Real average weekly earnings
- Bankruptcy filings
- Weekly same store sales
- Real weekly retail sales
- Annual S&P 500 interest expense.
Following a 1.5% monthly rise, the average Au9999 price in July reached RMB456/gram, the highest ever. Meanwhile, the average daily trading volume of Au9999, a proxy of China’s physical gold demand, declined m/m – seasonality played a key role as gold consumption is usually weak at the beginning of Q3. The record-level gold price may have added pressure.
All is well, according to July macro data releases. Growth is holding up and inflation is moderating at a fair clip, a likely contributor to ETF outflows and weaker coin sales in July (1.6t, down 0.7t y/y). July also witnessed what is likely the last Fed hike in this cycle and revived optimism that a soft landing lies ahead for the US economy.
The ECB and BoE continued their inflation fight by raising interest rates further in July. However, expectations are now beginning to shift, with futures markets now pricing peak rate expectations in October, two months earlier than they did a month ago. A worsening economic outlook in both countries has certainly played a part.12 European gold ETFs lost a further US$1.3bn (18t) during the month.
Reported net purchases totalled 55t in June – the latest data available – the first month of sizeable global net buying since February. A return to net buying from Turkey, following three consecutive months of substantial net sales, combined with purchases from China, Poland and others outweighed minimal sales during the month. As noted in our recently published Gold Demand Trends Q2 2023 report, the underlying positive trend in central bank gold demand remains intact.
Outflows from global physically-backed gold ETFs13 continued in July (Table 2), but narrowed compared to June. Meanwhile, holdings reduced to 3,387t.14 Nonetheless, driven by a stronger gold price, total assets under management (AUM) increased by 2% m/m to US$215bn. Asia was the lone accumulator of inflows in July. European funds once again led global outflows, shedding US$1.3bn, and North America was a close second. Flows in North America (+US$567mn) and Asia (+US$177mn) remained positive y-t-d. Europe dominated global outflows by a loss of US$5.5bn while the ‘Other’ region suffered a relatively softer decline of US$164mn.
Table 2: Global gold ETFs shed ounces in July
Gold ETF holdings and flows by region*
*Data to 31 July 2023. On Goldhub, see: Gold-backed ETF flows.
Source: Bloomberg, Company Filings, ICE Benchmark Administration, World Gold Council