Market update – 2,500 and more reasons to own gold

Gold unfolding above 2,500 USD

Price of yellow metal continues to show strength with further record highs. Data from US futures market also sends bullish signals. We’re writing these words on Wednesday 21th August and just last week gold price has reached three more record highs and entered weekend with a new record (Friday PM dump didn’t occur). In US futures trading current record high was closer to 2,540 USD. Spot price reached highs at 2,510 USD on Friday and weekly session closure occurred just slightly below. New price levels had been generally defended hence we could perceive that as healthy price action. On Tuesday mid-day we’re at 2,523 USD levels - new spot records, with possible 2,600 price range being seriously considered short-term.

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Valuation of one unit of Dow Jones Index is now at exactly same level as it was in August 1971 - during ‚temporary suspension of dollar to gold convertibility’ announced by US president Nixon. Problem is that such similar valuation also occurred in 1929 and 2007. And so, may be considered as indicative on troubles.

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At 2,5k USD per troy ounce of gold, typical 400 oz gold bar produced for LBMA market (more on its specs in our analysis‚ LBMA accreditation - facts, not myths’) is now worthy 1 mln USD - for the first time in history.

In addition, as gold started year 2024 at 2,081 USD per ounce, such price growths allowed yellow metal to became top performing traditional asset year to date. With gold delivering this calendar year ROI at 20%+ and SP500 at 18%+, if yellow metal would continue to deliver better returns than US stocks, this hopefully should give a good boost to valuation of gold miners. Currently gold miners (GDX) hit 52-week highs, but generally they may be still considered as undervalued. Juniors (GDXJ) still lag in comparison, but it’s not something unusual.

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Following shock in Japan on 5 August, prices on the stock markets have also recovered significantly. Although significance of carry trade cannot be ignored and remains on list of potential issues. In addition, alarming data from the US property market was published again. Housing starts and building permits reached a 4-year low in July. It is questionable whether this will have a lasting impact on investors. But the trend in the economic data is not good anymore.

Let it be additionally confirmed by US Bureau of Labour Statistics, which will make revision on April 2023 - March 2024 employment data, reducing number of workplaces created by even 1 mln. Which simply means that all ‚better than expected’ monthly employment reports of that period were artificially boosted up, giving investors picture too bright than it was in reality. Whether it was intentional or not, we do not dare to answer, leaving judgment to our esteemed readers. However jobs were one of the important indicators followed by market participants, as each month markets were responding to said optimistic data with further growths. We pointed that out in our ‚Merry Crisis and a Happy New Fear, p. 1’ analysis.

In addition to the variety of economic problems, there are also uncertainties of geopolitical nature. Will Iran launch a major military strike against Israel? And will this lead to a renewed escalation of the Middle East conflict? What of Ukraine? What of Gaza and West Bank? And few more other possible chokepoints or barrels of gunpowder just waiting to be ignited. Gold price generally reacts to geopolitical shock events in the short term scale - that means shorts-ripping spike and reversal or partial reversal occurring within couple next days. Just like we seen in January 2020, February-March 2022 or October 2023. Which again indicates that recent growths on price are to be attributed to general macro picture and not single ‚event’.

However with regards to macro and economic data, these seem to be usually priced in advance into price of gold by market participants, depending on possibility of occurrence. Hence, assuming we won’t experience significant pullback now, there are reasons to believe markets priced in economy weakness and liquidity injections to occur soon, in form of Iong awaited cuts on interest rates. After all, ECB did first step towards that in June, BoE as well in August. Now all eyes are on FED.

Again, in our ‚Merry Crisis and a Happy New Fear, p. 1’ analysis we indicated, that FED made cuts would rather occur second half 2024, late Q3, Q4. And we did that while general consensus was at ‚it is time to do that now’. Pace, frequency and range of possible rate cuts should be indicative to the subject of ‚how bad economy is’. Although it doesn’t have to be inflicted in general price of equities. What that means is - markets may very likely continue to grow (just look at SP500, Nasdaq or Dow Jones - all hovering near recent tops, negating recent corrections) although possibility of deeper correction cannot be entirely negated. Above is not to be considered as financial advice.

Weakness on USD provides fuel

And here’s another important thing to consider, this time regards to USD - gold relation. Of course we tend to value gold in US dollar in our analysis, just as financial markets do so.

DXY index measures strength of USD relative to basket of six foreign currencies. It has been established in 1973 as one of the measurement tools created after dissolving fixed fx exchange towards floating valuations (in result of unilateral ending of Bretton Woods and failure of Smithsonian Agreement). DXY composition evolved in time but currently it is as follows: Euro is, by far, the largest component of the index, making up 57.6% of the basket. The weights of the rest of the currencies in the index are JPY at 13.6%, GBP at 11.9%, CAD at 9.1%, SEK at 4.2% and CHF at 3.6%. And so, with DXY starting 2024 at 101 points and being right now at 101.40 means generally no change.

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But during course of 2024 USD had ups its and downs within this range (with March local bottom at. 102 and April-May tops at 106.2), and when narrowing picture on Dollar's most recent performance, USD is diving hard. We’ve got opening above 103 last Friday, the dollar index closed at 102.39 after a 0.62% decline. Monday's trading saw further weakness, with the index dipping below 102 for the first time since early January 2024. This marks a substantial over 2.11% loss for the dollar in August alone, following a 1.74% decline in July. And this happened at very fast pace.

Generał approach among investors is very much affected by the oncoming US presidential elections. Upon victory of Democratic candidate, markets generally expect further weakening on dollar, and just the opposite upon victory of Republican. Above is generalized approach, which we aim to develop more in depth in the nearest future. Especially since one of the candidates endorsed price controls After all, 2024 was year in which world feasted on lot of dishes in form presidential, parliamentary and local elections. But US presidential is always to be considered as main course served. Especially in times of extreme polarization.

However on more short-term timing, the driving force behind gold's strength and the dollar's weakness are high expectations on potential interest rate cuts by the Federal Reserve. FED maintained rates at their current level of 5.25% to 5.5% during the July FOMC meeting, but yet again market expectations for a rate cut in September are high.

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With that said, all eyes are now on the upcoming annual economic symposium in Jackson Hole. Event, sponsored by the Federal Reserve Bank of Kansas City since 1978, brings together central bankers, business leaders, policymakers, economists, and government officials to discuss critical economic issues. This year's symposium, titled ‚Reassessing the Effectiveness and Transmission of Monetary Policy’, is scheduled for 22-24th August.

Market participants are eagerly anticipating Federal Reserve Chairman Jerome Powell's speech on the first full day of the event. His remarks are expected to provide insights into the Fed's current strategy and outlook, potentially influencing both gold prices and dollar strength in the coming weeks. But ‚Reassessing Effectiveness’ seems to imply certain stance change.

To wrap it up - gold refused to sell off immediately after growths, and broken up from all possible restraining technicals. Economy has cooled down, which is reflected by US numbers among many (we didn’t even mention ISM indexes around the world nor other interesting indicators), and price of gold now reflects strong anticipation for rate cuts in US. Recent weakening of USD also provided fuel to recent growths.

All of that historically had positive impact on price of yellow metal. And it seems now to be at some share priced in.

Comex technicals behind new price paradigm

To analyze what happened in gold trading on the Comex last week, first need to look at the Commitment of Traders data with the positions of the largest trader groups in gold futures trading as at 13 August 2024. That is on the beginning of week when price breakout occurred. Here we observe strong increase on all trading sides. Net short position of the ‚commercials’ increased by 8.7% to 292,502 contracts. On the opposite side, net long position of ‚large speculators’ rose by significant 12% to 267,264 contracts. Net purchases by ‚managed money’ (hedge funds, investment companies) rose by strong 18% to 177,915 contracts.

Meanwhile, open interest rose by 5% to 505,872 contracts as at last Tuesday. And by the close of trading on Friday, total of all open gold contracts on the Comex had risen by a further 4% to 526,568 contracts. In a comparison of the previous week (Friday to Friday), open interest rose by 8.6%. High liquidity provided high volume and high volume contributed to strong price action.

Meanwhile, open interest in gold options trading rose by 5.5% compared to the previous week to 1,168,432 options. The put/call ratio increased to 0.552 (previous week: 0.525). This means that more options traders are once again betting on falling prices, which is not unusual given the sharp rise. For every 100 put options, there were recently 181 call options (on previous week: 190). In general, however, we continue to see a high level of overall gold price optimism in gold options trading.

Meanwhile, gold holdings in Comex vaults decreased as in the previous week, most recently by 230,000 ounces to 17.49 million ounces (previous week: -140,000). Gold stocks in the ‘eligible’ category available for immediate delivery to customers fell by 160,000 ounces to 9.61 million ounces (all figures rounded).

With an open interest of 526,568 contracts, traders traded a total of 52,656,800 ounces of gold in the form of standard futures (100 ounces per contract) at the end of the past trading week. This means that gold futures trading on the COMEX was only 33% covered by corresponding inventories on Friday (previous week: 36%).

Comex operator justifies this shortfall with the fact that only a fraction of futures contracts are actually physically settled. This means that at the end of the contract month, parties mainly close out their positions by cash settlement. How high the proportion is, can also be seen from a weekly mandatory announcement. For example, CFTC reported 21,509 applications for physical delivery of gold for the contract month of August. This means that now 4,328 were added within one week. By comparison, there were only 3,759 delivery notices in the previous month.

By contrast, in the previous record month, which was June 2020, traders insisted on physical delivery of gold traded as futures 55,102 times. Far from records, but market strength in gold futures trading has increased significantly in the environment of the new highs. This means that the rising gold price has attracted new traders to the market. Meanwhile, China's influence on the international gold price has apparently continued to wane with lower premiums being paid.

In addition, there have recently been more requests for physical delivery of gold traded as futures and gold stocks on the COMEX have continued to shrink. All of this suggests that precious metal is becoming increasingly attractive in the eyes of Western investors. All of that comes with increased possibility of volatility. However, the past few weeks have shown that the price of gold always bounces back after slumps. The recent record rally is also an unmistakable signal.

On fears, yields and injections

On the beginning of analysis we mentioned on persisting fears troubling financial markets, which contributed heavily to recent correction on indices. Mood on stock markets has since changed somewhat. CNN’s Fear and Greed index measures in simplified way how market participants do feel in a scale o zero to 100. Currently stock market is at 44 points which is considered as borderline between fear and neutral. However for majority of August (1st to 16th), it was fear accompanying investors, and for certain part of said period it even turned to extreme fear.

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Another exemplary index - VIX measures level of implied volatility of a wide range of options, based on SP500. It is therefore known as investor fear gauge as it reflects investor’s best predictions of near-term market risk. On the 5th of August it locally peaked, while on 20th of August stood at 14.97. In comparison, Covid spike was measured at 66.04 points while October 2008 events unfolded to 79.13 points. On market crash of 1987, theoretical level of VIX reached 172.79 - unbeatable record. For now, fears seem to be gone with the wind and indices are already heading back towards their record highs.

Apart of annual Jackson Hole symposium already mentioned, there will be more news from the US FED on Wednesday evening. This is because it will publish minutes of its July meeting. And in the centre of interest will naturally be one subject - of when and to what extent the FED will cut interest rates this year. Now, this is typical mood accompanying financial markets in times when interest rates plateau. With higher crediting costs, liquidity goes down, and therefore trust in between market participants that usually have capital allocated in ‚currently indispensable assets’ dives as well. After all, majority of portfolios are composed of stocks and bonds combination. While bonds experienced double digit losses on market value this cycle, stocks experience strong ups and downs, with only a handful delivering solid profits. One such remarkable example is Nvidia.

One alternative to gather capital are buyback programs, not applicable currently as FED continue attempts to shrink its balance sheet. Other, are now expensive credit lines. And at the end of the day, main purpose of financial institutions is to deliver profits to the board and shareholders. Should therefore be no surprise that financial institutions simply prefer having access to cheaper credit lines, and so hope for FED to make rate cuts since basically late summer of 2023.

However considering all quantitative easing that occurred since 2008, solid liquidity injections made during pandemic, extensive asset purchase programs performed by main central banks in the world... well, it is good to be too big to fail...

Another aspect to consider regards to gold are yields on government debt. How one influence the other? Generally speaking, it can be said that if government bonds with good credit ratings offer higher interest rates, they become more attractive to defensive institutional investors. In contrast, interest-free gold as a form of investment then appears less worthwhile for such capital managers in normal times. On Tuesday, 10-year US government bonds yielded 3.88%. This compares with 4.3% at the end of July and 3.92% last week.

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Automated trading systems also react to such influences. However, bond yields are only one of many aspects that play a role in the development of gold demand and the gold price. When safe havens are sought on the capital markets, precious metals often rise, while bond yields fall (rising bond prices).

Conclusions

The Dollar index - DXY just sank to its 7-month lows, while gold is trading at record highs. That is to be perceived typical reversed correlation for these two classes of assets. However nowadays, pace occurring bears a meaning and important message. Despite high expectations on rate cuts (due to profit making. assumptions), markets do indicate in this way, that FED is about to make major policy mistake by making cuts too soon, affecting economy. Despite of that, expectations are high.

Let’s hand it over to Reuters, at the very end:

(…) Federal Reserve will cut interest rates by 25 basis points at each of the remaining three meetings of 2024, one more reduction than predicted last month, according to a slim majority of economists polled by Reuters who said a recession is unlikely.

Investors also said a violent, but brief market sell-off also was a driver of aggressive rate cut calls, related to the unwinding of large leveraged positions as a result of a sudden, sharp rise in the Japanese yen.

Inwestorzy stwierdzili również, że gwałtowna, ale krótka wyprzedaż na rynku była również motorem agresywnych wezwań do obniżki stóp procentowych, związanych z nieprzewidzianą sytuacją na rynku pracy.

Although some Fed officials have hinted rate cuts are coming, most economists in the Aug. 14-19 Reuters poll were not expecting a rapid series of rate cuts. Recent data, including last week's strong retail sales report, suggests the economy is performing relatively well even as inflation recedes.