AEQUITAS

We ex­am­ine why the pre­cious metal is unloved and po­ten­tial cat­a­lysts to get the price mov­ing up­wards

Shares - - CONTENTS - By Russ Mould, in­vest­ment di­rec­tor, AJ Bell

What needs to hap­pen for gold to shine again

As reg­u­lar read­ers will doubt­less be painfully aware, this col­umn shares War­ren Buf­fett’s view that the best time to start re­search­ing – or even buy­ing – an as­set is when no-one else is. Any­one who sym­pa­thises with that con­trar­ian take on mar­kets and as­set al­lo­ca­tion might there­fore be think­ing about gold, not least be­cause no-one else seems to be.

In Au­gust the metal dipped be­low $1,200 and reached its low­est level since Jan­uary 2017.

This slide may seem all the more sur­pris­ing to some ad­vis­ers and clients given its sta­tus as a per­ceived haven in times of strife. It would have been log­i­cal to ex­pect the gather­ing crises in Turkey and Ar­gentina, for ex­am­ple, to take gold higher but noth­ing of the sort has hap­pened.

This could be be­cause mar­kets are still of the view that Turkey and Ar­gentina rep­re­sent a lit­tle lo­cal dif­fi­culty but noth­ing more and cer­tainly noth­ing with the power to roil mar­kets on a global ba­sis. Such com­pla­cency proved ill-founded when it came to a de­val­u­a­tion of the Thai baht in 1997 and a down­turn in the Florida prop­erty mar­ket in 2007 and only time will tell this time around.

But, be­sides faith in the global eco­nomic out­look, there is an even more pow­er­ful force that is work­ing against gold (oddly, just as it is against Turkey and emerg­ing mar­kets more gen­er­ally). That is the dollar.

DOLLAR DY­NAMIC

Like most raw ma­te­ri­als, gold is priced in dol­lars, so if the green­back goes up then the pre­cious metal be­comes more ex­pen­sive to buy in lo­cal-cur­rency terms, po­ten­tially damp­en­ing de­mand (or so the the­ory goes).

Fi­nan­cial mar­ket par­tic­i­pants’ aware­ness of this historic re­la­tion­ship means they could also look to ride dollar strength by short­ing gold, sell­ing it now to try and buy it back later at a lower price and pocket the dif­fer­ence as a profit.

It is pos­si­ble to track short po­si­tions in gold via fu­tures con­tracts on Amer­ica’s COMEX, for both com­mer­cial and non-com­mer­cial in­ter­ests.

Each fu­tures con­tract rep­re­sents 100 ounces of gold.

Com­mer­cial traders are likely to be gold min­ers or con­sumers of the metal such as jew­ellers who may use fu­tures con­tracts to hedge their ex­po­sure or lock in prices at a cer­tain level, but non-com­mer­cial traders are fi­nan­cial mar­ket spec­u­la­tors.

What is in­ter­est­ing here is that non-com­mer­cial short gold fu­tures con­tracts have surged from 73,905 in June to 222,210, a fig­ure which is more than dou­ble the amount of bear­ish po­si­tions on gold a year ago and the high­est go­ing back at least 20 years.

The im­pli­ca­tion is that bears are clearly stomp­ing on gold, with dollar strength as the most likely pre­text for do­ing so.

Con­trar­ian ad­vis­ers and clients may be in­trigued to note that short fu­tures po­si­tions against gold have surged by more than 100% year-on-year on sev­eral oc­ca­sions since 2010. Gold sub­se­quently ral­lied on al­most ev­ery oc­ca­sion, al­though it must be ac­knowl­edged that 2013 a notable ex­cep­tion.

SHORT SQUEEZE

Fans of gold will there­fore be ar­gu­ing that all of the bears have piled in, given the huge num­ber of short po­si­tions, leav­ing gold ripe for a snap­back if the scep­tics are put to flight.

The ques­tion is what could be the trig­ger for that? One pos­si­bil­ity is cen­tral bank pol­icy, be­cause of its im­pact on the dollar.

The US cur­rency is gain­ing as the US Fed­eral Re­serve re­duces its Quan­ti­ta­tive Eas­ing pro­gramme and mar­kets pre­pare them­selves to be fur­ther de­prived of liq­uid­ity by an end to in­creased QE from the Euro­pean Cen­tral Bank. The Bank of Eng­land has al­ready stopped adding to QE, leav­ing just the Swiss Na­tional Bank and the Bank of Ja­pan to cre­ate money out of thin air.

Gold has done well when cen­tral banks have been adding to QE (amid fears the mon­e­tary au­thor­ity have lost con­trol of the global econ­omy) and badly when they have not (in the view that the cen­tral banker have ev­ery­thing in hand and there is no need to cre­ate more ‘money’).

In sum, gold may well thrive if cen­tral banks, for any rea­son, find them­selves obliged to stop rais­ing in­ter­est rates, or start cut­ting them, or – most dra­mat­i­cally – crank up the elec­tronic print­ing presses and turn to QE once more.

That may seem out­landish right now.

But an ex­pan­sion in the ag­gre­gate as­sets of the Bri­tish, EU, Amer­i­can, Swiss and Ja­panese cen­tral banks from $3.5tn to $15tn from 2007 to 2018 would have seemed like science fic­tion a decade ago and the Fed moved to bail out the Long Term Cap­i­tal Man­age­ment hedge fund at a cost of $3.6bn in 1998 after the Asia and Rus­sian debt cri­sis.

Who knows, Turkey’s cri­sis could still have wider im­pli­ca­tions than we dare imag­ine, to the ben­e­fit of gold and gold min­ers, while a surge in global in­debt­ed­ness since 2007 could still oblige cen­tral banks to re­turn to record-low in­ter­est rates and QE if – and when – the next global down­turn comes.

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