Investment Commentary

• Gold continued its strong June, closing the week higher (LBMA 0.8%, XAU 0.7%) for the sixth straight week. It was as high as $1,440 on Tuesday, but gave up some of its gains late in the week as Fed Chairman Powell made comments that a 50bps cut in July was ‘too much’. Gold had its best month in two years, rallying nearly 9%; it is up 10% this year.

• Gold made all-time highs in a few currencies last week, most notably the Australian dollar, but gave back some of its USD early-week gains as it became the most overbought (RSI) on a weekly basis since 2016. Given the sharp move over the month of June, a pullback would not be unexpected. $1,365 should act as strong support.

Gold price

Source: Bloomberg

• As global yields continue to fall, and in some cases turn negative, there appears to be a direct correlation between global net negative yielding debt and the price increase in gold, highlighting that as yields decrease, the opportunity cost of holding gold decreases making it more attractive.

Amount of global negative net debt and price of gold

Source: Bloomberg

• Global gold-backed ETFs grew 5% in June, adding $5.7bn, or 129t, the most inflows in tonnage since February 2016. Total AUM grew by $15bn or a 15% increase over the month, the largest increase since 2012. We will release our monthly/1st half gold-backed ETF flows report on Tuesday, 7/9.

• COMEX net longs continued to increase meaningfully to 868t from 737t, the highest level since Q3 2016.

COMEX net longs

Source: CFTC, World Gold Council

• Investors continue to favor buying calls versus puts, which is reflected in put/call skew which remains at an all-time low.

3m put/call skew

Source: Bloomberg, World Gold Council

Gold price behaviour:

• Gold fell last week, after a six-week rally (LBMA -1.0%, XAU -0.6%). 
• This occurred primarily on Friday, driven by a strong US Job’s report that drove the probability of a July 50bps cut from 25% to 0%, as well as a surprise increase in India’s tax duty to 12.5% from 10%.

Fed rate cut probability

Source: Bloomberg

Volume and Liquidity:

• Gold trading volumes continued to increase meaningfully to start the month with last week’s average at $184bn a day. The June average was $169bn vs YTD average of $115bn.
• Interestingly, the Shanghai Futures Exchange volume increased significantly, with daily volumes at $14.5bn, well above the YTD average of $5.8bn; we recently highlighted Chinese investment behaviour in a blog.

Technicals: 

• The gold price rally finally paused, which was expected given the extremely overbought conditions. 
• The gold price could be forming a bullish flag, which if confirmed would project the price of gold to approximately $1,550.

Volatility:

• Realized volatility caught up to implied volatility as 30-day realized volatility is at the highest levels since 2016.

30-day gold realized volatility

Source: Bloomberg

ETF Flows:

• July began with small global inflows of $72mn, all from North America. 
• Global inflows are $5.1bn on the year, led by European funds, that have added $4bn or 78% of global net inflows. 
• We will be releasing the June ETF flows report on Tuesday, at 8am EST.

For Australian precious metals investors 21 June was a momentous day, with the price of gold topping A$2000 per ounce for the first time ever. 

The chart below plots the rise in the price of the yellow metal since since the start of the year 2000, with gold rising from under A$450/oz over this time frame. This equates to a return of more than 8% per annum to any investor astute enough to have invested at the turn of the century.

The latest rally that pushed gold beyond A$2000/oz represented the culmination (for now) of a move that began in earnest back in September 2018. The gold price has climbed approximately 25% in AUD terms over the past nine months, compared with the 20% gain we’ve seen in the USD gold price over the same time period.

There are many global factors that have driven this rally, including: 

• The sharp correction in risk assets during Q4 2018, which reignited demand for gold as a safe haven asset.   
• A continued plunge in global bond yields in 2019 as the pool of negative yielding debt rises back above US$12 trillion
• A recalibration of interest rate expectations in the United States, with many economists now expecting the Federal Reserve to cut rates in July
• Continued concerns regarding the US-China “trade war”, as well as escalating geopolitical tensions in the Middle East

Why Has Australian Dollar Gold Outperformed?

The bond market gives a clear explanation why gold priced in AUD has outperformed over the past 18 months. 

Since the end of 2017, the Australian 10-year government bond yield has dropped from over 2.65% to below 1.30%. The move dwarfs the decline in US 10-year yields seen over the same time period, which fell from 2.41% to 2.01%. Unsurprisingly, this has led to a fall in the AUD/USD exchange rate, and the outperformance of AUD gold.

The outperformance is captured in the following chart which plots the performance of gold in each currency, with both rebased to 100 for easier comparison. 

The chart also shows the spread between US and Australian 10-year government bond yields, which was sitting at +0.26% back in December 2017, but had plunged to -0.73% by late June 2019. 

The reason for the sharp fall in bond yields is a continued deterioration in the Australian economy, which on a per capita basis fell into recession at the end of 2018. 

The most significant driver of this weakness has been the correction in residential property prices in Sydney and in Melbourne, which are both down more than 10% since their 2017 peak. 

This decline has been driven by multiple factors, including more cautious lending from Australian banks, a notable uptick in dwelling supply, and a sharp retraction from foreign buyers who now account for just 3.5% of demand for established properties, down from a peak closer to 10% back in 2013. 

The negative wealth effect from this house price decline has impacted everything from unemployment to retail sales to wage growth, while the associated decline in housing turnover is dragging down state government budgets. 

Will the Outperformance Last?

The chart below, which plots the AUD/USD FX rate, as well as the spread in 10-year bond yields between the United States and Australia since the turn of the century, suggests there is a meaningful chance of further significant falls in the value of the AUD. 

In early 2001, when the AUD/USD FX rate was below US$0.50, investors could earn over 5.25% in an Australian government 10-year bond, a premium to the 4.91% US 10-year treasuries were offering at the time. 

Today the Australian dollar sits closer to US$0.70, despite the historically unusual territory we find ourselves in, with investors now earning almost 40% more if they choose to lend to Washington instead of Canberra for the next 10 years. 

In time, we’d expect the current yield differential to exert downward pressure on the AUD, especially if Australia’s terms of trade, which are back near the levels seen at the peak of the resources boom in 2011 were to falter.  

Pressure on the local currency may be exacerbated if the Reserve Bank of Australia (RBA) − which this week cut the local cash rate to a new all-time low of just 1% − continues to ease monetary policy in the coming months in its efforts to stimulate growth. 
 
The bottom line is that while the AUD gold price is high, it’s entirely justified why it is trading above A$2000/oz. Whether it’s a faltering local economy, a fragile property market, negative yield differentials, low and falling rates or a weakening currency, there are many good reasons why astute investors typically allocate 5-10% of a diversified portfolio to gold. The strategic case for gold as strong as ever. 

• The gold price rebounded last week and has risen 7 out of the last 8 weeks (LBMA 1.4%, XAU 1.2%). The price strength was driven by a weaker US dollar and a steepening yield curve, which was the byproduct of  Fed Chairman Powell’s comments that were more dovish than expected and all but assured a July rate cut.
• The probability of a July 50bps cut spiked again from zero to 25%; this despite CPI data coming in higher than expected (a sign that inflation could be creeping into the market); the US 2/10 curve is near the ytd highs.

July Fed Rate Cut Probabilities

Source: Bloomberg

• COMEX net longs for the previous two weeks were released and showed that two weeks ago, net longs were 917t; it is worth noting that all-time highs in net longs are 1,082t. They fell back to 854t last week but remain very high.

COMEX Net Longs

• Futures open interest has risen to over $100bn this month, driven mostly by COMEX, and is 26% above the ytd average.
• The gold price remains in a bullish flag formation, which would project the price of gold to ~$1,530 if confirmed.

• North American funds were the primary drivers of the $290mn of global gold-backed ETF inflows last week. Flows have continued their June trend with $362mn coming in through the first half of July, almost entirely from North American funds. On the year, there have been global inflows of $5.4bn, with 72% coming from Europe.

• Gold was higher by 4% last week (XAU +3.9%, LBMA +3.9%), as US/China trade negotiations hit a snag, the US dollar fell, and rates continued to fall. Gold prices are at all-time highs in over 20 countries, having rallied 8% in the past month and 17% this year in US dollars.

• COMEX net longs are near all-time highs and are long 1,078 tonnes. When net positions are at extreme levels, short or long (as they are now), this can precede a reversal in the price, although not necessarily immediately.

COMEX Net Longs

Source: CFTC, Bloomberg

• Gold trading volumes are well above short- and long-term averages at $213bn a day this month. That is 87% above the 2018 average. The Shanghai Futures Exchange volume continues to increase significantly, with daily volumes at $21bn, well above the ytd average of $7.0bn.
• There is over $3tn worth of gold futures option open interest at the $1,500 strike over the next two months which is many multiples above traditional amounts. Some of this probably has to do with the psychological level of $1,500, but this could act as a magnet for prices, so gold could hover around that level.

• Overall, there were $1.7bn worth of inflows globally last week across all regions. There have been $2.5bn of inflows so far in August also spread across the regions. Year-to-date flows surpassed $10bn last week as assets in global gold-backed ETFs have grown 8% this year, with inflows split between North America and Europe.
• Lower rates continue to help the opportunity cost of holding gold. US bond markets are currently pricing in the probability of a 50bp cut of 28% and a 72% probability of a 25bp cut for the next meeting, despite previous statements by Fed Chairman Powell that signaled a wait and see approach. In all, the US 2/10 curve has moved into single digits, flirting with inversion.

Fed rate cut probabilities in September

Source: Bloomberg