Why has gold not been benefiting more from such negative sentiment? As we describe in more detail in the next section, the strength of the US dollar has likely been a key factor dampening the gold price’s reaction to rising risk and quantitative easing remains a crucial driver of both US dollar and gold price performance.
Gold and the US Dollar
The gold price has traditionally tended to be negatively correlated to the US dollar, highlighting gold’s value as a hedge against structural US dollar weakness. The elevated level of risk and uncertainty that has led to investors’ deleveraging has forced the US dollar higher and played a key role in hampering the performance of gold since September 2011, making it less positively correlated to systemic risk in Europe. Growing investor concerns about the potential implications of a disorderly exit of Greece from the Euro, and of Spain and Italy’s growing problems, spurred investors’ demand for “safe haven” G3 bonds (US Treasuries, JGBs and Bunds) sending yields to all-time lows in June 2012.
While one would intuitively expect that this would also benefit gold, the gold price was on a general declining trend during this period. A key reason for this is that with the stress focused on Europe, the increased risk perception also pushed up the US dollar versus the Euro, triggering selling of gold by short-term investors. In other words the European crisis has been enough to spark Euro weakness, but has not yet become severe enough to trigger fears of an imminent Euro Area breakup and force capital flows into gold.
The Gold ‘Bubble’ and Investor Dynamics
Suggestions that gold is in a bubble are worth exploring because of the potential implications for investors. If the current trajectory of the gold price is mapped against previous instances of bubble formation, gold appears to be continuing a gradual uptrend rather than exhibiting bubble characteristics.
Comparing gold performance over the past 10 years to the tech stock bubble, which peaked in 2000, and to the previous gold bubble of the early 1980’s, shows that the current price of gold remains at levels around one-third the magnitude of previous bubble events. This analysis suggests gold has more room to move and with further central bank stimulus broadly expected by the investment community, how are investors currently positioned?
Gold Exchange Traded Product holdings have increased substantially in recent months, rising to a record level of 79mn ounces in August as strategic investors have taken the view that gold in the current price range represents a good level for accumulation. Futures investors by contrast have tended to be far more momentum oriented, tending to buy when the gold price is rising and selling when the gold price is falling. Excluding the multi-year lows in net long gold futures positions seen in 2012, in our view it is significant that net long positions in gold futures are still hovering at the lowest levels since April 2009. With net long positions still over 50% below the peaks of 2011, it appears there is a potential for a further rebound in positioning if fundamentals turn positive for gold and price momentum attracts additional interest.
Conclusions
The recent behavior of the gold price has caused some investors to question gold’s “safe-haven” properties. A deepening crisis in Europe and uncertainty about the likelihood and timing of another round of quantitative easing by the US Fed have pushed investors to the sidelines, with cash and G-3 bonds the primary beneficiaries. Investor deleveraging and capital flight from the Euro has forced the US dollar higher, dampening gold’s sensitivity to systemic risk and hampering its performance since September 2011.
However, with “operation twist” coming to an end in the next few months, US employment data indicating a stagnating US labor market and Europe’s politicians still far from a comprehensive solution to the region’s problems, the likelihood of another round of US quantitative easing is increasing. While the rising expectation of another round of QE3 is the most likely catalyst for the next leg of the gold bull market, the lower probability, but high impact risk of a full-blown Euro crisis could also be a catalyst for the gold price to break higher.
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