By Joe Foster, Portfolio Manager and Strategist, VanEck.
Joe Foster, Portfolio Manager and Strategist, VanEck.
Since June, the gold price has enjoyed a relentless advance of over $250 per ounce, to a six-year high of $1,557 on September 4, then spent the rest of September consolidating around the $1,500 level.
The gold price found support on September 12 when the European Central Bank (ECB) joined the US Federal Reserve Bank (Fed) in a monetary about-face by easing policy nine months after signaling it was done with ever-looser policies.
The ECB cut deposit rates to minus 0.5% and will start buying $22 billion worth of debt beginning in November to try to avoid a Euro-zone recession. Also, gold was supported by a missile and drone attack on a large Saudi oil facility that knocked out 5% of global oil supply.
Systemic risk surfaced when the overnight repo market lacked the liquidity to handle the confluence of a corporate tax payment with the settlement of a US Treasury debt auction on September 17. Banks refused to lend as repo rates trended as high as 10% and the Fed was forced to inject billions of dollars into the financial system to address the squeeze. Post-crisis banking rules, the Treasury’s voracious appetite for cash, and the Fed’s management of its trillions of dollars of balance sheet securities created unintended consequences that have been resolved for now. However, it begs the question as to how financial markets will behave under a less benign variety of systemic stress.
The gold price was kept in check as trade tensions with China eased somewhat when the two sides agreed to talks in October. Gold faced further headwinds as the S&P 500 came within a hair of its all-time high on September 19 and the US Dollar Index trended to a new 28-month high on September 30. We wonder who is investing in US assets amid all of the impeachment chaos, systemic stress, and fiscal irresponsibility. Perhaps the machines really have taken over.
The gold market showed resilience until September 30, when dollar strength seemed to overwhelm the metal. We have been wondering whether an interim correction in the gold price would come at $1,500 or at higher levels. We now have the answer as gold fell $47.91 (3.2%) in September to $1,472.39, and it looks like October is shaping up to be a month of correction. Gold stocks also gave back some gains as the NYSE Arca Gold Miners Index (GDM) fell 10.0% and the MVIS Global Junior Gold Miners Index declined 11.2%.
Gold continues to beat expectations
The upward move in gold prices so far this year has caught most investors by surprise. There have been strong inflows to the bullion exchange-traded products (ETPs), yet anecdotally, we have seen little flows into gold equity funds. For many, this move harkens back to the first half of 2016 when the gold price advanced $260 and the GDM doubled. However, the 2016 move wasn’t sustained, and gold and gold stocks pulled back and went nowhere for three years.
Equity investors are now understandably cautious and reluctant to step in. With the correction now in motion, it looks like we will soon find out whether 2019 was another flash-in-the-pan or the beginning of a new bull market. The macro backdrop today is much more supportive than it was in 2016. Both the expansion and the general equity bull market are now the longest on record. Global growth is slowing materially. Real rates have been falling and are expected to continue falling for the foreseeable future. Negative-yielding debt has reached an astronomical $15 trillion globally and is growing. Global leadership seems to keep getting worse.
Prior to 2019, $1,365 was the established upside resistance level for gold. Once upside resistance is broken, it often becomes downside support. Therefore, in the current correction, gold could pull back to $1,365 and still maintain a strong bull market trend. It is equally possible that gold might consolidate at higher levels, say in the $1,400 to $1,450 range. The duration of this correction might take as little as a month or continue to year-end. While we will only know the details in hindsight, the strong macro drivers in place suggest this correction will only be a bump in the road, not the end of the line. Also, given gold’s 2019 performance, we will not be surprised if it continues to beat our expectations.
(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)