Gold in a Time of CrisisWriting about financial markets can be a bizarre occupation. When everything’s fine, you find yourself focusing on all that could go wrong. Then when something does eventually go wrong, you have to cover it until everything is fine again.
The latter half of 2019 was dominated by the improbable rally of US equities from all-time high, to a higher all-time high. Keywords such as “global slowdown”, “repo market” and “US-China trade war” kept cropping up regardless of the asset that you were covering. And now, the beginning of 2020 has been all about “coronavirus”, “Covid-19” and “the worst drop since.”
Writing about gold is also pretty interesting. Gold has a peculiar relationship to other asset classes. In times of plenty it sits there looking shiny, being no one else’s liability but yielding nothing. You can understand its long history of being called a relic of barbarism, even before Keynes referred to the gold standard as a barbarous relic.
It just doesn’t allow for the kinds of tricky financial engineering that keep expansions going well past their prime. Its nature as a safe haven means that gold bugs who hoard and focus on it to the exclusion of all else, develop reputations as permabears and are often dismissed as such. It does, however, seem to react immediately when anything in the global economy seems off. Even permabears get to have their day in the sun.
Where We Find Ourselves
During Monday’s trading session, the price of the yellow metal surged to a high of $1704 – the highest it’s been since 2012. Risk aversion is high as markets attempt to price in both coronavirus fears and new concerns of an oil price war between Saudi Arabia and Russia.
Looking further back, gold has been in an unbroken up-trend since mid-August of 2018. Save for a couple of periods of consolidation last year, from the end of February to the end of May and then again from September to December, it has been on a slow and steady upward march.
This move has seen the precious metal going from lows of around $1160 back in 2018, to its recent highs of just over $1700. That’s a 46% run in about 19 months. Not particularly life changing, but that’s not why people invest in gold. People invest in gold so that when corrections like the one we’re witnessing occur, they don’t lose their shirts.
Yield Curve Inversions
Bond markets speak volumes about the health of the economy and gold seems to be one of the few assets that listen. If we go back to August of 2018, we can see that there was a bond market catalyst behind gold’s move up. 2018 was the year that markets started paying attention to yield curves again.
During that summer, the spread between 3-month and 10-year treasuries tightened in a manner last observed during the crisis of 2008. It then inverted. When the yield curve inverts, shorter-dated treasuries yield more than their long-term counterparts, which signals growing uncertainty regarding the economy’s long-term prospects.
This last leg of gold’s two-year uptrend was initiated in August of 2019 by another, even more important, bond market catalyst. That was the month when the US 2-year and 10-year yield curve inverted. The two and ten are the most closely watched bond yields by market analysts. This is because their inversion is a highly reliable recession indicator, having successfully predicted every US recession since the 1950s.
Gold markets took both of the above inversions seriously, despite US equities being at or around their highs during both events. According to Credit Suisse, following an inversion of two and ten year treasuries, stock markets will rally on average by around 15% for another 18 months before recession finally sets in around 22 months after the inversion. We’re now 7 months on from that inversion and the S&P 500 rallied by over 19% before coronavirus hastened what many were regarding as inevitable.
Covid-19’s impact on the global economy has led to a spike in volatility across the board. Whether it’s equities, currencies or commodities, all the relevant measures have been going through the roof. Gold has not been immune to this. At the time of writing, the CBOE’s gold volatility index (GVZ) is up by 117% since mid-February. During the March 9 session it was up by over 300% , surging from just under 11 on February 13, to a high of over 45. On that day the index closed at its highest level since June of 2013.
Losses Being Covered
At the moment gold prices seem to be being pulled in opposite directions. On the one hand investors are flocking to gold as it fulfils its traditional role as a safe haven asset. On the other, it has already made impressive gains since it began its upward trajectory back in August of 2018. Every top since then has been sold by traders as they attempt to book their profits.
What we’re seeing now is likely more than just profit-taking. Recent market turmoil has left many investors vulnerable to being liquidated elsewhere. Many are in danger of—or are already receiving—margin calls. Sometimes you sell because it’s prudent to do so. At other times you sell because you have no other choice. This is likely to be the case now as investors scramble to raise money in order to cover their losses in other asset classes.
Bonds Yields Crashing, Interest Rates to Zero
On March 3 the Federal Reserve conducted an emergency 50 basis point rate cut to a range of 1-1.25%. The market reacted by dumping, signalling that this was nowhere near sufficient. In the wake of this emergency cut, the market is now broadly expecting another 50 basis point cut at the Fed’s March meeting, followed by a further 50 basis point cut in April. This effectively takes US rates down to the zero lower bound.
As investors flee riskier assets like stocks and oil, they’ve been ploughing into the perceived safety of US treasuries, causing yields to drop precipitously. In the first two weeks of March not only did the 10-year treasury fall to a record low of under 0.7%, but the entire US treasury yield curve fell below 1% for the first time in history.
In such a scenario gold becomes even more attractive to investors because not only does it receive capital from the safe haven play, it’s also likely to receive inflows from capital that would ordinarily have been earmarked for bond purchases.
Things to Keep an Eye On
The CBOE’s gold volatility index ought to be closely monitored. While it’s true that we’re entering unexplored territory that’s highly favourable of risk-off assets like gold, we’re also at multi-year highs in the precious metal. This will exacerbate swing if gold continues to rise and stocks continue to fall.
Additionally, the infamous Fed is still in play here, with many speculating that the Federal Reserve will be forced to step in and save markets once again, like it did during the Great Recession. The manner in which markets shrugged-off this recent intermeeting cut makes it look like only significant and unprecedented intervention will prevent a global recession. Quite what this would look like is anyone’s guess, but even a hint of it is almost certain to adversely affect the price of gold.
Finally, gold mining stocks are an interesting case in this environment. This traditionally risky and capital-intensive business has just received a windfall of sorts. Firstly, the price of the thing they’re pulling out of the ground is up some 10% this year alone. Secondly, their greatest expenditure just tanked in price and is currently down 25% since the beginning of the year. In such an environment you can expect the industry’s narrow margins to increase and earnings to outperform other sectors in the coming quarters.
By Giles Coghlan, Chief Currency Analyst at HYCM
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