After gold was pinned to the $1460/tonne level for most of November, it started breaking out towards the end of December -- to everyone's surprise, as it seemed to go against the risk-on sentiment and asset price reflation that was taking place for most of Q4 2019, following the Fed's massive liquidity injection. Over the light holiday volume period, these moves can often be discounted, as most are away from their desk or too inebriated from the Christmas eggnog to be able to observe a break away from logical correlations.
Typically, gold should not have been rallying, with equities up and bonds falling -- as was the pattern towards end of the year. That move alone took a few shorts by surprise. To make matters worse, the attack on an Iranian General last week did not help, as gold shot up to $1550 earlier this week and then touched $1600 as Iran retaliated last night -- targeting two U.S. air bases in Iraq. S&P 500 futures fell to a low of 3195, but have since recovered up to 3225, with Brent oil price rallying up to $71.25/bbl and settling down to $68.7/bbl before UK open.
Officially, gold falls in the realm of commodities, but it trades and acts unlike one. A commodity is an instrument that is dictated predominately by its physical demand/supply, which dictates its true pricing power. If that were the case, then there is no shortage of supply for gold. And if anything, demand is robust but manageable. It has been and is more of a Macro asset, dictated by geopolitics (safe haven trade), recession (purely risk aversion), inflation and real yields. Typically, when there is doom and gloom about and fear about a severe clash in geopolitical strategy -- even chances of a war -- gold tends to be well bid. Other reasons are highly debatable, as a clear relationship has never been found.
Taking a step back from sentiment, one of the truest measures for gold is the level of real yields in the U.S. economy. Gold tends to go higher as real yields fall. This is one of the true "fundamental" relationships out there. Geopolitics and war can of course distort the price of gold for obvious reasons.
Real yield is defined as the nominal yield of a bond minus the rate of inflation. As inflation rises, clearly the real yield falls, assuming nominal yield of the bond stays the same, pushing gold higher. Real yields in the U.S. over the last few weeks have been moving lower, trading around -0.07% as of January 6 on the 5-year U.S. bond yield. As tensions began to mount this past week, U.S. Bonds rallied taking nominal yields lower together with inflation moving higher is causing real yields to fall even further, forcing gold even higher.
On Wednesday, gold is extremely stretched with a 9-day RSI (relative strength indicator) trading at 94. In lay terms, over a period of 9 days readings between 30 and 70 (0-100 being the range) are considered "normal"; but anything outside of that range is not sustainable for a long period of time.
Even the speculative bets on gold show a long of 328,000 contracts, the highest over the past 10 years! It would imply purely from a tactical point of view that in the very near-term, gold price is overdone and can pull back closer towards its break out area.
After the attacks Wednesday morning, Iran has stated that if there is no retaliation from the U.S. after these attacks, they will stop attacking. The ball is in Trump's court whether he will want to escalate this recent development or just take this as a one-off attack following the killing of their General.
One would hope that there would be some logic and rational response from his cabinet and not some eager anti-Iranian officials looking to use this opportunity to wage war during an election year to boost voter approval. Taking a step back from flexing their muscles, it does not appear that a war is in anyone's interests, as it would collapse financial markets and oil could soar past $90-100/bbl, even, depending on how much oil is destroyed.
Iran has about 4 mln bpd current production roughly and then you have Saudi close to 10 mln bpd. Even with U.S. SPR reserves being released, there is no sense in drawing scenarios, as it can get ugly very fast. Above all things, Trump wants to keep markets elevated to claim victory over his presidential campaign and not cause an oil price spike that will squeeze the average U.S. consumer, causing a certain recession.
The Everything Bubble is held together by a very delicate balance of lower rates, not-QE QE and weaker dollar. If this were to be upset, one is not entirely sure how much or how fast the Fed could respond with a balance sheet closer to $4.2 trillion already. There are only two trades in the market currently. If you believe this is the start of an outright war between two nations, sell equities, buy bonds, and buy gold or any safe haven asset.
If you believe that this situation will subside as all nations intervene to stop matters from getting worse, then gold is overdone here and will sell off, and equity markets are well bid, as seen by how fast they rebounded from Asian market initial selloff.
I am in the latter camp, as it does not suit the U.S. political election agenda to rock the boat so aggressively, especially as the Fed just rescued the markets only three months ago when the repo market was about to blow up.
Oil is different matter altogether. It moved up to about $66/bbl Brent (before attacks even began), shooting as high as $71.25 this morning, but trading closer to $68/bbl now. One can argue there is not a lot of war premium in the price, unlike what sell-side houses are claiming.
Forgetting an outcome of war, the oil price will be well supported -- as it has been all throughout December, as winter heating demand season picks up and OPEC+ cuts have stabilized the inventory picture with stocks drawing. As central banks and the U.S. Fed pumps liquidity, global economic growth will pick up. This is the reason commodities in general are picking up, as the Fed has given the green light of inflation shooting higher, implying their hurdle rate to raise rates is much higher, if they even consider raising rates.