If you woke up one morning and were faced with a barrage of headlines -- ranging from Trump tariffs to be imposed on all its trading partners, Chinese yuan devaluing 10%, emerging markets down 20% and Iran/Saudi tensions on oil shipping routes to yield curve inversions predicting recessions -- one asset class would immediately come to mind: Gold. You would think, darn it, I missed the buying opportunity in gold, only to pull up your screen quote to see it down 10% since January's year-to-date highs. So what gives?
This is the constant frustration among retail and high net worth investors. If the economic recovery is on its last innings, and isolationism among nations threatens global economic growth, why would a safe haven, a store of value, not be up more? The answer lies not in the perception of gold, but more in its store of value and cost of carry.
Very simply put, when interest rates rise and real yields move higher, the opportunity cost to store gold is higher, hence making it less attractive to own. Gold is more of a store-of-value trade and less of a fundamental trade, unless the world goes to hell and all political leaders lose the plot entirely. Not interested in releasing my own version of the Prophecies of Nostradamus, so let's stick to fundamentals for now.
It is hard to categorize gold as a commodity per se. It does have demand and supply dynamics, but its demand comes from more than just its physical state. And there is certainly no shortage of supply, so saying gold is "cheap" is more a case of how it fits in with the USD trade and interest rates than its inventory balance. It trades in dollars, so does tend to share the inverse correlation relationship with the dollar -- as do some other commodities.
If you take a look at the speculative positioning in gold, they started to get pretty bulled up in September last year (when gold peaked again). Today, the spec position in gold is getting down to the same level that it fell to in June 2017, before it rallied well into the September peak.
The bullish sentiment in gold has dropped to its lows this year as well, but something strange has happened this time: The open interest in gold has been rising. Usually when gold falls, the open interest falls, signalling that longs are cutting their exposure. This move higher implies that gold short positioning is increasing on this move lower -- everyone is going short gold now. Money managers hold record short positions in gold right now. From a macroeconomic view of the world -- with higher interest rates ,as central banks have been removing monetary accommodation -- this makes sense. But everyone seems to be on the same side of the trade.
The third quarter usually sees strong jewellery sales in China and India on seasonal demand, favourable consumptions trends and a rise in consumer income. However, this is just a short-term tailwind. Can't hurt. More important is the dollar trade and the outright short positioning in gold that can move things here.
Being contrarian by nature, the setup looks great for a bounce (aka pain trade higher squeezing out and catching everyone by surprise). And dare I say it, if the Fed decides to hold off on its rate hiking path (just for a bit to let markets settle down), the dollar can fall quite hard, and the rally can be even more vicious. Ouch!
I have never been a physical fan of gold, but the trader in me always appreciates risk/reward. Tactically, being long gold here looks good. But don't fool yourself, it is just a trade. I am certainly not a gold bug.
