Week ending 15 March 2019

ETF Flows: Weekly flows were higher last week $479mn. This was mostly from North American and European Funds. Global funds lost $641mn this month driven by North America and Europe. YTD flows are higher by $1.1bn (1.1% of AUM) with inflows coming from the US and Europe.

Liquidity – COMEX net longs held steady around 300t net long for the previous week. Liquidity remains high in the gold market with daily trading volume at $127bn. This has been driven by a 15% m-o-m increase in the LBMA OTC market and 29% increase in the COMEX futures market.

Option Exposure and Volatility – 30-day realized volatility in gold picked up over the past month from 8 to 11 which is in the 80th percentile over the past year, highlighting some of the recent daily moves. Call skew remains rich suggesting investors are paying for upside exposure. Today, 5k December $1,405 - $1,485 gold option future call spreads traded on the COMEX. This represents $65bn in notional and is profitable on expiration with a move 7.5% to 14% higher.

Technicals – Gold broke back above the $1,300 level and continues to trade near its 50-day average. The 50-day should continue to act as resistance until there is a meaningful close above the level.

Week ending 1 March 2019

• Broad Markets - Globally stock markets were slightly higher last week, the standout was China +7% with positive US/China trade-related talks. Stocks are climbing to start the week on trade optimism. The 2/10 curve in the US steepened to its highest levels of the year at 20bps. Commodities as a whole fell with the GSCI down 2%, led by oil down 2.5%. The US dollar was flat. President Trump lashed out at Powell and his ‘tightening policies’ over the weekend. Probability of a hike this year is at 8% and a cut at 2%, slightly more hawkish than the previous two weeks. The ECB meeting is this week and probability of a hike on the year is close to 50%. 
• Gold – Gold was sharply lower last week (LBMA -1.3%, XAU -2.7%) closing strongly to the downside on Friday as the US dollar strengthened and stock markets moved higher

• Technicals – Gold broke support and is well below the 50-day moving average and $1,300. It stalled at ~$1,350 as we thought might happen and is starting to become slightly oversold. $1,275 is probably the next psychological support level.
• Flows by time periods – Weekly flows were lower last week -$926mn. This was mostly from North American and Asian Funds. Global funds lost $1.3bn in February driven almost entirely by GLD and Huaan Yifu.

• Liquidity – COMEX net longs were updated as of 2/22 and we saw and increase in net longs to 531 tonnes, the highest levels since April of last year. Gold market liquidity fell in February from $114bn to $104bn a day versus January. However, Volumes were heavy on the first day of the month at $128bn with the selloff on Friday.

• Broad Markets – There continues to be a divergence of the equity and bond markets as equities continued their move higher with yields falling (bonds increasing) last week. Bond holders appear to believe the Fed’s recent language suggests an economic downturn in the US, while equity owners seem to believe in a new ‘Powell Put’ as stocks had their best quarter in 10 years. Stock markets in the US and Europe were 1-2% higher with Asia slightly lower. The 3m/10yr curve in the US remains negative with shorter-term rates falling. The 10-yr closed at levels last seen in 2017 when the effective Fed Funds rates were 1.3% lower. Last week, economic advisor Larry Kudlow went as far as to say the Fed needs to cut rates 50bps immediately despite the stock market again trading near all-time highs. Fed futures are pricing in a 2/3 probability of a 25bps cut and 23% chance of a 50bps cut this year. The GS Commodity index was flat, despite oil gaining 2% as precious metals fell. The US dollar gained globally, in particular, against the pound as the UK had another failed Brexit vote. There is a 4th Brexit vote scheduled today in the UK. Investors are bracing for earnings reports which come into full swing next week.
• Technicals – Gold has now formed the right shoulder of a bearish head and shoulders formation. A close below $1,290 could precipitate a sharp move lower to a projected price of $1,230 or a percentage move of 5%.

• Option Exposure and Volatility – With the sharp moves last week, 30-day realized volatility in gold increased to 12, which is the 99th percentile over the past year. Interestingly, implied volatility in gold remains low, both for short- and longer-dated options suggesting, investors have not yet bought into the idea it will remain volatile. There is over $1tn of options open interest in futures at the critical $1,300 level which could create resistance.
• ETF flows by time periods – Weekly flows were higher last week by $256mn. This was mostly from North American Funds. Global funds had small inflows in March driven by North America, having reversed the early-month outflows. YTD flows are higher by $1.9bn (1.8% of AUM) with inflows coming from the US and Europe. We will be releasing our monthly ETF flows report this Thursday 4/4.
• Liquidity – Volumes in the OTC and COMEX markets increased meaningfully in March to $125bn a day a gain of 15% m-o-m. Open interest in gold futures is at $80bn, slightly above the ytd average. COMEX net longs increased from 349t not 426t net long, the highest level since February.

Broad Markets – Stock markets were marginally higher last week (8 April-12 April). US stocks were up by 0.6%-0.7%; Japanese by 0.3%, EM by 0.2% (in US dollars) while European stocks were flat. Treasury yields in the US also increased after the release of the Fed minutes from the March meeting and a speech by Vice Chair Clarida last week. Bond markets are still expecting a 40% chance of a rate cut by the end of the year, but this has come down substantially from 70% only a few weeks ago. Similarly, the US 3m/10y treasury curve remains flat but has moved again into positive territory, indicating a reduction in expectations of a recession by bond investors. And while the Fed appears to be on a watch-and-see approach, economic advisor Kudlow’s recent comments reiterate that the executive branch is not expecting rate hikes any time soon. Meanwhile, the UK and the EU agreed to delay Brexit until the end of October as the UK Parliament tries to find common ground and a way forward. This proved positive for both the pound the euro which rallied against the US dollar. German bund yields rose and while the front end is still negative, the 10-year bund is again on positive territory. Lastly, the commodities complex moved higher, led by oil (+1.3%) which is now close to 40% up for the year. 

Gold Market – Gold had mixed results last week (LBMA +0.5%, XAU -0.1%). Support by a weaker dollar was counterbalanced by higher yields and continued strength in stock markets. Gold has moved below $1,290/oz but remains marginally higher for the year; it has been pulled back below US$1,300/oz twice over the past month and has reverted back up near US$1,280/oz. We expect US yields to influence gold’s short-to-medium term performance as broad markets continuously adjust expectations about what the Fed may do over the coming months (see: The impact of monetary policy on gold, March 2019). 

Major markets performance year-to-date*

*As of 12 April 2019.Computations based on total return indices in US dollars for Bloomberg Barclays US Treasury Aggregate, Bloomberg Commodity Index, New Frontier Advisors Global Balanced Index, MSCI EAFE and EM Indices, S&P 500 and Nasdaq. Spot prices for LBMA Gold Price, Solactive Gold Long Dollar Index and LBMA Silver Price.
Source: Bloomberg, ICE Benchmark Administration, Solactive AG, World Gold Council

Positioning and liquidity – Volumes in the global gold market have decreased to US$105bn/day in April – approx. 20% down relative to March. Open interest in gold futures is at $81.9bn. COMEX net longs increased slightly to 365t and are close to their year-to-date as well as their 2-year average.

Gold-backed ETF flows by time periods – Globally, gold-backed ETFs experienced marginal outflows of US$28mn on the week ending 12 April. Net positive flows into European funds were offset by heavy net outflows in North America. Year-to-date, flows remain positive by US$1.5bn (1.5% of AUM) mostly supported by Europe inflows. Flows in the US are still positive (+US$174mn), recent outflows have dented an otherwise positive trend in US-listed low-cost gold-backed ETFs.**

**Low-cost US-based gold backed ETFs are defined as gold-backed ETFs that trade on US markets with annual management fees of 20bps or less.

Gold-backed ETF flows

*As of April 2019.
Source: Bloomberg, Regulatory filings, World Gold Council

• Gold was sharply lower last week (LBMA -1.8%, XAU -1.5%) on the back of higher yields, a stronger US dollar and a risk-on environment. We expect US yields to influence gold’s short-to-medium term performance as broad markets continuously adjust expectations about what the Fed may do over the coming months (see: The impact of monetary policy on gold, March 2019).
• The gold price remains below the key technical level of $1,290, which represented the neckline of the bearish head-and-shoulders pattern. Absent a near-term rally, we would anticipate a fall to $1,225 based on that technical indicator

• COMEX net longs decreased sharply last week from 365t to 173t, the lowest levels since 12/3/2018 as gold has fallen 2% in the past two weeks.

• Globally, gold-backed ETFs experienced outflows last week of US$769mn. European flows were negative US$335mn. Month-to-date, flows are negative (-US$1.2bn) worldwide. North American gold-backed ETF flows are now negative on the year. Global flows are still positive on the year with the European region the only one with positive flows
• As US markets near all-time highs, many experts argue the market is ‘tired’ with US/China trade relations, a dovish Fed, and weaker expected earnings baked into stock prices. We will get further clarity on the economy this week as many tech companies report along with a GDP report on Friday that will highlight the effects of the government shutdown in Q1 on the economy

Broad Markets – Stock markets were higher globally last week, except in China and EM, which fell 5% and 1.3% (US +1.5%, Europe: 0.5%).The stock market performance in China is likely linked to the comments made about the country’s economic stimulus plans. China said they would support the economy, but there are worries of a near-term pullback in support (policy-tightening fears) given the better than expected first quarter GDP results. The BoJ left rates unchanged, which was expected, but said it does not intend to raise rates before 2020, slightly changing expectations in-line with the US. The US reported much better expected 1st quarter GDP (3.2% annual pace), resulting the yields falling and the 2/10 curve flattening. The German 10-yr yield fell into negative territory again. Despite the stock market at all-time highs, bond markets are implying a 65% cut of a rate cut this year! Half of this probability implies a cut of 50bps. Commodities were lower by 1% last week, with oil down 1.1%. The pound is at a 10-week low vs the US dollar driven by reports that May’s talks with Brexit opposition leaders have stalled. The Fed reports its rate decision on Wednesday and there is no expected rate change. US/China trade discussion continue this week and US Treasury Secretary Mnuchin said enforcement mechanisms are “close to done.” Tech bellwethers Alphabet and Apple report this week.

Current Implied Fed decisions before year-end

Source: Bloomberg

ETF Flows: YTD gold-backed ETF flows are now negative by $141mn (0.14% of AUM) with all regions except Europe having outflows. Globally, gold-backed ETFs experienced outflows last week of US$845mn. Month-to-date, there are negative flows  (-US$2.0bn or 2% of assets) worldwide. Invesco Physical Gold ETC in the UK and Xetra in Germany have captured the most inflows with Europe but total flows in Europe are now negative on the month.

Liquidity: Volumes in the global gold market have decreased to US$109bn/day in April – approx. 13% down relative to March. COMEX net longs decreased last week from 173t to 112t, the lowest levels since 12/3/2018. Gold futures options open interest fell sharply last week, notably at the $1,300 level with notional going from ~$1tn to ~$500bn.

Options and volatility: Implied volatility across tenors remains in the single digit percentile over the past year between 8 and 9, despite the recent moves (increases in realized volatility) in gold prices and technical breaks. Put/call skew also remains relatively inexpensive despite the weakness in gold this month. The muted implied volatility and perceived risk in put skew may be due to the fact that gold is effectively flat for both the month and year.

We often get asked about cryptocurrencies and whether they represent a potential replacement for gold, as well as what role, if any, bitcoin should play in a portfolio. We have written on this topic in these papers: Cryptocurrencies are no substitute for gold, and Cryptocurrencies are not a safe-haven. 

Although cryptocurrencies and blockchain technology look promising as a whole, they clearly do not represent a substitute for gold either in theory or in practice.

The reasons gold is very different from cryptocurrencies:

Gold:

• is less volatile
• has a more liquid market
• trades in an established regulatory framework
• has a well understood role in an investment portfolio
• has little overlap with cryptocurrencies on many sources of demand and supply
• is a safe-haven investment.

Volatility:

• Cryptocurrencies extreme daily and intraday volatility disrupts its use as a medium of exchange and discourages strategic investments 
• Gold’s volatility is slightly above the stock market as a whole, in line with most fiat currencies over time.

Liquid transparent market:

• Gold trades $150bn a day, nearly 100x that of bitcoin
• Gold pricing is consistent across exchanges in all forms 
• Some bitcoin futures markets have closed due to lack of trading, and price discrepancies exist across exchanges
• Physical gold can be bought for a small percentage above spot price, and purchasing gold via allocated, physically-backed gold ETFs can cost less than a basis point over spot 
• As an example, Bitcoin charges many percentage points (we’ve seen as high as 9% on some exchanges) via the process of the bid/ask spreads and entering and exiting positions
• The most liquid bitcoin closed-end exchange traded product currently trades 40% above its net asset value. This means that investors have to wait for a 40% appreciation before they can realise their investment’s face value.

Regulation

• We have seen how lack of regulation has led to multiple crypto exchange defaults and fraudulent activity, resulting in losses amounting to billions
• The government could begin to regulate cryptocurrencies by directly or indirectly discouraging investors’ ability to transact with them
• Ultimately, gold trades in a widely authorised and regulated market with transparency.

Demand:

• Gold demand is diverse, coming from jewellery, investment, technology and central banks
• Cryptocurrency demand is highly speculative or investment related, as there is little proof of its use as a medium of exchange
• Gold has a track record dating back to 600 BC, whereas bitcoin has only a 10-year track record.

Supply:

• The stock of both bitcoin and gold tends to grow in the low single digits; both have finite amounts of supply
• However, there is nothing to prevent an enhanced cryptocurrency from being launched, devaluing those already in existence. 

Investment

• Gold is a well understood investment tool in portfolios as it:
  • has been a source of returns rivaling the stock market over the long-term 
  • protects against inflation
  • is a portfolio diversifier, useful during downturns in the market
  • trades in a liquid market.
• Cryptocurrency performance has been remarkable over the long-term but has seen massive haircuts during some periods and has failed during periods when it should have thrived.  Cryptocurrency has:
  • failed as a hedge in late 2018, behaving like a risk asset, down on par with technology stocks, falling 55% in the fourth quarter. Gold was up 9% over the same period
  • developed into a highly volatile investment as timing is vital
  • scarce liquidity and non-transparent pricing.

We continue to acknowledge the innovation taking place in the cryptocurrency and blockchain spaces and believe there will be a role for this technology in the future. However, it is clear that cryptocurrencies are not a replacement for gold and gold should remain a component in all investment portfolios.

Disclaimer: This information does not purport to make any recommendations or provide any investment or other advice with respect to the purchase, sale or other disposition of gold, any gold related products or any other products, securities or investments, including without limitation, any advice to the effect that any gold related transaction is appropriate for any investment objective or financial situation of a prospective investor.