The main buyers of gold, at least until the break of its 200-day moving average at $1130 last Wednesday, were not traditional commodity players. Rather, it was the wider macro community
- US market participants friendly to gold, but are observers rather than active players
- Gains led by non-traditional players
- More interest in gold now, and questions about it, than for the past 2 years
- Viewed as the final financial market hedge
- Vol no longer cheap, risk reversals up to 2.5 for calls, matching the 2011 high
- For now the runup looks overdone, but buy dips
I spent last week in the US, and the topic of conversation was gold, gold and more gold - from current clients, clients that haven't been active since the tail end of the bull run, clients of my FX/equity/rates colleagues, and potential clients. In other words, everyone wanted to talk about gold. I haven't seen such interest in years.
Why the interest? The short version
Gold is currently viewed as the final financial market hedge. US data is deteriorating and the Fed won't be raising rates any time soon; China is set to contract further; CNY devaluation will continue and encourage a move into gold; negative interest rates in Europe, Switzerland and Japan make gold relatively more attractive; real yields are falling; nominal yields remain low; gold positioning is light, gross shorts still relatively high.
Given all that, there's a lot of buyers, right? Wrong: many expressed the view that they'd prefer to wait, miss the early rally and buy into momentum later on.
Why the hesitancy? The short version
Those who are hesitant to jump in argue that, technically, this is still a bear market for gold; that the US isn't going into recession, indeed raised rates in December, and the potential for a reversal of that hike is very low; that gold (ETF) buyers have become more fickle in recent years; that physical demand is tame; that there's no inflation and little potential for it; that gold couldn't hold onto any upside moves in 2015; that in a commodity bear market, the recent rally only makes gold look very expensive; that the gold/oil ratio is too high.
These are all reasonable arguments, but the factors pushing investors into gold are considerably stronger. The 2015 price bursts were predominantly rooted in positioning, with shorts very extended and net length at low-single-digit levels. The current rally hasn't been driven by short-covering, and in fact gross shorts still remain quite high, 13.9 moz as of Feb 2, down from a high of 19.2 moz in early December but very elevated compared to the weekly average of 6.2 moz during 2009-2011. Also net long positioning at 8.9moz is far from frothy.
Who has been buying gold? Observe the changing trends
The main buyers of gold, at least until the break of its 200-day moving average at $1130 last Wednesday, were not traditional commodity players. Rather, it was the wider macro community, which has predominantly expressed its views through long-dated (6m+) options or GLD options. Traditional players became much more active upon the break of the 200 dma and the psychologically important $1150 level. Repeatedly in meetings last week we encountered would-be participants who were happy to miss out on the early stages of the rally and buy into momentum later on. ETF inflows have been very large, 3.4 moz year-to-date. To put this into context ETF holders were net sellers last year totalling 4.2 moz. Also worth noting here is that the ETF buying hasn't just been GLD led – the GLD has seen inflows of 1.96 moz and the rest has emanated from European contracts.
On a much smaller scale, we've seen longer-term holders buying back calls as well as private banks buying physical gold and also returning interest in fully allocated, segregated gold - the ultimate safe-haven trade. None of these have been in tremendous size, but what matters is the trend change. Currently the gold market is littered with changing trends – factors on their own which would not raise must attention, but put them together and they add up to a considerable alteration in market dynamics. That makes me sit up and pay attention.
Despite a contained rally in January, February's move looks excessive
I've been friendly to gold since early January. Whether you think the US has been hard-done-by of late on the back of China and that data up ahead will turn, or indeed if you're more bearish on the US, there's a need for some financial market insurance this year. I believe that gold is in brand-repair mode, and that it has performed admirably as a safe haven vs equity and the DXY this year. Gold's reputation has been heavily tarnished by its intense capitulation from the 2011 highs, and mistrust lingers for some market participants. Many commented on the steady pace of gold's move higher, at least up to Thursday, with a tinge of disappointment that gains weren't less constrained. We have viewed the slow pace of the move until last week as a sign of a healthy, reasonably sustainable move. Gold's breakout since late Thursday looks excessive and toppish. It is now due a pullback before resuming its climb. Interest in buying puts was evident today, and the market has seen decent selling. Opposing forces are at play right now: the non-traditional players want to keep buying, while the traditional participants look to book profits.
Vol is no longer so cheap: 1m was 14.5 after US payrolls, exploded to 17.0 after the CME close, printed 18.75 yesterday and traded down to 17.4 today. Our options desk has seen vol sellers in the 6m area. Risk reversals have exploded, with the 1m rr up to 2.5 for the calls, matching the 2011 high.
The missing factor in all this is physical demand. Much of Asia is out for Lunar New Year celebrations, and these buyers won't be returning until the second-half of February. Gold is trading at a discount in India, and physical demand in Europe isn't causing any ripples. In my view, there's potential for Chinese demand to increase in the months ahead for three reasons: 1) China like to buy into momentum, 2) further CNY devaluation should encourage gold buying, and 3) money that is coming out of equities and real estate will be channelled into gold.
Yellen's testimony key for the next move
Fed Chairwoman Yellen's semi-annual congressional testimony on Monetary Policy tomorrow and Wednesday is "likely to be a key opportunity for the Fed to send a proactive & cautious message, stabilize sentiment and offer effective policy relief" according to our global macro strategy team. That will likely determine the next $50 move in gold.
What's the trade?
I've been searching for the optimal trade to express the view that gold looks toppish short-term but that dips should be bought. Trading ahead of Yellen's testimony tomorrow is probably too risky, however – and outright options look a bit too rich. Let's get tomorrow out of the way and see the lay of the land.
No one is talking about inflation
You'll note that I've barely mentioned inflation. It came up in about 20% of meetings, and in most cases I was the one to bring it up. No-one is trading gold for inflation or deflation reasons. Gold has a role to play as a longer-term inflation and deflation hedge, but in a disinflationary environment the metal typically struggles. Few are concerned about that. Gold is trading now as a safe haven, full stop.
The risk of hedging
XAUAUD is trading at its highest level since October 2012. In my view, the potential for hedging from Australian producers is considerably more elevated than it was at year-end. The big obstacle is that hedging still remains an ugly word for the world's major producers. Whether considerably higher prices forces a re-evaluation of this view remains to be seen. This would be a sizeable headwind for gold, should hedging emerge in size.
Edel Tully | Global Head Precious Metals Distribution
UBS Investment Bank | 100 Liverpool Street | London EC2M 2RH
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