As you’re undoubtedly aware, gold hit a fresh one-year high overnight on Friday as the dollar plunge accelerated.
Gold has of course benefited from haven flows tied to North Korea and also from the perception that the risks emanating from Washington aren’t set to abate any time soon, the recent exercise in fiscal can-kicking not withstanding.
Gold’s recent rally has of course reignited the eternal debate about the relative merits of owning largely useless pieces of metal as a “hedge” against the end times. But perhaps more important than the debate about whether it makes sense to own something that can’t be eaten or burned as protection against a scenario that leaves us all living in Cormac McCarthy’s The Road, is the question of where real rates are headed.
“Gold is still just an inverse real yield play,” Bloomberg’s Mark Cudmore wrote last week, adding that “since most major central banks — such as the Fed and the ECB — are more likely to hike rather than cut rates as their next move, despite a lack of sustained inflation, it’s unlikely the next major move in real yields is going to be lower.”
And then there’s the liquidity issue or, more simply, the problem that comes with saying you own gold when you really only own paper that’s supposed to represent gold. As Goldman put it in a recent note, “one lesson [investors have] learned is that if gold liquidity dries up along with the broader market’s, so does your hedge—unless it is physical gold in a vault, the true ‘hedge of last resort.'”
Finally, there’s the very straightforward contention that gold is simply overbought at current levels.
Whatever the case, folks are trading – by God. “Volume on the Comex in New York hit a record in August as North Korean tensions and a weaker dollar boosted demand for the metal,” Bloomberg noted in a short piece dated Friday, adding that “some 6.55 million contracts — worth almost $900 billion now — changed hands last month, more than when Donald Trump was elected U.S. president or during substantial price spikes and slumps.” Here’s the chart:
Well, BofAML is out weighing in on all of this and it’s probably worth highlighting a few key points from their latest on the subject.
First of all, the bank says positioning isn’t stretched enough to warrant the derisive “contrarian indicator” label. To wit:
Given the somewhat mixed demand backdrop on the physical market, most of the rally was driven by non-commercial market participants, which is not unusual. To that point, Chart 4 shows that assets under management at physical backed exchange traded funds have risen in recent weeks. Similarly, Chart 5 highlights that non-commercial futures positions on CME have risen. At the same time, we note that positioning remains well below a z-score of +2, a level that is a contrarian indicator.
Next, BofA notes that although the GFSI isn’t indicating panic just yet, there are signs that investors are looking to hedge:
Starting with cross-asset volatility, Chart 6 shows that BofAML’s Global Financial Stress Indicator remains within recent ranges, suggesting that investors and traders are comfortable with the current status quo on the markets. Having said that, Chart 7 highlights that some uncertainty has been creeping in, with the Skew sub-index sharply higher of late, suggesting that purchasing protection against downside has become more popular.
Lastly, here’s what they have to say on the real rates argument:
US real rates have lost ground again… Changing tack and looking into the fixed income space, gold prices tend to be inversely correlated with US real rates (Chart 9). This is important because US real rates have given back most of the gains seen around the US presidential elections in 2016. Acknowledging that inflation and inflation expectations remain subdued, this was heavily influenced by a decline of nominal rates. The repricing in rates is also picked up by Chart 10, which shows that the US yield curve has been flattening.
Without a reason to think they’ll be a marked change in the way Washington does business, it’s hard to see how that’s going to reverse course – especially in light of the figurative and literal head”winds” from Harvey and Irma.
The bottom line: “Putting it all together, we see a high likelihood that the current macro-economic backdrop will persist and push gold towards our $1,400/oz price target.”
Position accordingly. Or else bet that the dollar will rally or eventually, a weaker dollar will drive up inflation.
Up to you.