Via Macquarie today:
Gold’s rally – too much, too soon
We are gold bulls. But short-term both the physical and financial sides of gold are flashing red, and we believe the price is set for a weak September.
At present things look rather different. The dollar gold price has enjoyed a decent rally since July, taking it to a peak of $1,300/oz briefly last week from a low of $1,205/oz on 10 July. That was the highest it had been since the US election (see Fig 1). This week it has settled back but remains around $1,290/oz.
This fits with our view that gold should be going up – we have a 4Q target of $1,325/oz and expect it to go even higher in 2018. What’s more, the reasons for which gold have been rallying are those we thought likely to push it higher – scepticism about the Fed’s ability to raise rates as fast as it believes, a sluggish US economy, and increasing geopolitical stresses, both in the US and around the world.
Nevertheless, we do not feel convinced by the latest rally and believe the gold price is likely to fall over the next month. We see three potential headwinds.
First, the risk of a stronger US dollar. Gold’s current elevated price and its recent rally are flattered by the weak US dollar. But thanks to a period in June/July, when the dollar was falling but gold did not rally (something we attribute to it being more of a step-change realignment for the euro, see this piece), it has underperformed. And as such measured in some other currencies, particularly euros, gold is actually down this year. While this does not in itself mean the dollar gold price is set to fall – you could as easily argue it should play catch-up – it does put it at risk from any resurgence in the US currency.
What might cause this?
One obvious possibility is an improvement in US economic data. The Atlanta Fed’s nowcast for 3Q is running at a rapid 4% annualised growth, reflecting a strong start by US economic data, while our US economist is forecasting a solid 3%. Both are above consensus of 2.5%. Furthermore US economic data often surprises to the upside in 2H after doing the opposite in 1H, as can be seen by the historical trend in the Citi Surprise Index (Fig 3).
Relatedly, we believe investors continue to underprice the hawkishness of the Fed. Although our US economist agrees the Fed will not manage the rate hikes it has pencilled in, he does believe they will raise rates again in December and once more in 2018, taking the Fed funds rate to 1.66%. Fed fund futures are currently pricing in a rate of only 1.44% by January 2019 (Fig 4).
Finally, and with less conviction, we might see a more stable political backdrop. In recent months the dollar has been hit by an apparent loss of faith in the Trump administration’s strategies and coherence, and while we doubt there is going to be a sea-change, recent personnel changes in the White House offer the possibility of at least a quieter period. One potential flashpoint – the possibility of a US government shutdown – seemed to be receding until Trump’s recent comments vis-à-vis his wall, and we still believe will prove a non-event.
Another potential negative for bullion is the health of physical demand. In particular we have been flagging a drop off in Indian demand in 2H given the extremely strong demand seen in 1H, partly front-loaded ahead of the introduction of the GST. July’s imports continued relatively strong at 52t, although that was the lowest of the year. August data is not yet available, but media and trade reports are that demand is very weak. Of course it might pick up, and September is often a strong month. But the signs are not great: it is noticeable that the spot gold price on the Indian MCX exchange is, allowing for import duty, now trading at a sizeable discount to the equivalent London price (Fig 4). Flows into China seem more robust, although July’s imports appear to have weakened despite the soft price.
Finally, we note that there is now less potential help for gold from speculators. The “managed money” net long on Comex as of 15 August was the longest it has been since last-September, and while that is not particularly out of line relative to the gold price (Fig 5), the shift from near short to long over the last month has been one of the largest on record, even expressed as a percent of open interest. Much of this has been due to a decline in shorts, with the gross spec short position down 80% in the last month to its lowest in three and half years. At the very least this limits the potential for further gains and raises the possibility of a sell-off.
We remain gold bulls but believe investors will find a more attractive entry point than today’s price. An improvement in sentiment towards the US economy and politics, coupled with a relatively long speculative position and little potential support from physical demand, all suggest September will be a weaker month, with $1,225/oz a plausible floor.
I agree with Macquarie that it s sell today even though I can see gold going higher in the short and long term. The reasons why are:
- DXY is all that matters to gold, as you can see in the CFTC chart;
- DXY has still to chop its way through the oil and US inflation softness (and any political shenangans) so it may have further short upside but it’s had a good run so taking profits is always a good idea;
- I see DXY higher next year on a firmer economy, tax cuts, eventual Fed tightening and slowing in both China and Europe.
Longer term, as we move towards an eventual Fed policy error, stock market meltdown and US recession, gold will take off again wit the return of QE and, what we all really need for deleveraging, helicopter money.
So, it really depends on where it fits in your portfolio. If it’s a trade then sell (or hold if you dare), if you hold it for longer term portfolio protection then buy the dips.