Asia Gold: Fractals of pain reverberate through markets

Various fractals of pain continue reverberating through markets this week as the most popular yearly, monthly, weekly, daily, and even possibly the most famous retail view of all time hit a brick wall at high velocity leaving many houses of pain in its aftershock. 

Overnight markets

Gold rebounded above USD1,900/oz on USD dip and the lack of US fiscal progress, but the downward correction may not have run its course as gold prices remain incredibly vulnerable to rising US yields and the apparent fall in trade risk premiums, as the US strikes a conciliatory tone around the upcoming trade talks. 

But fortunately for gold investors, they have friends at the Fed, with speakers unanimously remaining incredibly cautious about the US economic recovery.

The gold market attempted to claw back some lost ground, and at one point, price action showed some moxy after a considerable upside surprise in US July CPI, with core month-on-month at 0.62% vs. 0.2% in the Bloomberg survey. But given that CPI remains partially a made-up number as much of the increase reflects either idiosyncratic changes, or prices normalizing after lockdowns this past spring, fast money just smacked that bid.

But, at the end of the day, if Tuesday’s price action around the vaccine was a test run for the real event, – where a single recession stopper in the form of a vaccine could theoretically have had the potential to moonshot the economic recovery, sending yields higher and possibly triggering central banks to pull back on stimulus – the market trial run to the vaccine news doesn't speak volumes about owning gold.

Given that near-term gold fortunes remain mostly in the hands of fast money and CTAs, we should expect "technical momentum" to drive the market over the near term. While there remains excellent support on the chart around $1,800, which is an awful long way down, another test of $1,900 could encourage more selling so nothing can be ruled out as gold market continues to struggle with liquidity issues that seem to be getting magnified by summer trading conditions. 

Still, that sticky demand between $1,875-1,925 continues to remind us that the global economy still faces a host of problems, suggesting the go-to remedy of more stimulus and lower rates will be the course of action. Again, a vaccine cure certainly does pose a significant risk to that view. 

USD and gold 

Gold is priced in the US dollar, so it’s trading higher for that reason, but that’s not the trigger to buy gold as the USD edged lower as the markets adopted a "risk-on" mood. 

Gold and bonds 

Bond markets had been pricing not only that interest rates would remain as low as far as the eye can see but also that the Federal Reserve and European Central Bank would up their bond-buying shortly. And in the Fed’s case, even the possibililty of introducing yield curve control. 

Anything that would cause a market to rethink that policy – such as a vaccine, the US and global economy improving faster than expected, or even US stocks printing all-time highs – is going to weigh on gold prices.

Inflation and gold 

Yesterday I suggested that Fed monetary policy will be unable to reignite inflation, given that for the last decade evidence in Japan indicates that monetary policy is ineffective at creating velocity around M2. Indeed, the Fed’s wishful thinking to nudge inflation above 2% is about on par with me hoping to shoot 75 this weekend at Bangkok Country Club: it doesn’t mean it is going to happen.

But there is some happiness to be seen on the other side of the inflation coin.

While inflation sustainably remaining above 2% is a long way off, it’s worth keeping gold in mind. In the 1970s, headline inflation had two surges – one in 1974, when inflation got up to 12.3%, and another in 1980 when it got up to 14.7% – which saw gold have a 423% appreciation and a 672% appreciation, respectively, in those two instances. 

While gold bulls are licking their wounds after Tuesday's price action, there’s still a chance inflation could surprise on the upside before the Fed explicitly targets inflation; it could provide some stability over the long term, however the short-term view is still a worry.

But if you need an inflation hedge, why not buy TIPS as the correlation of quarterly returns to gold is unsurprisingly high at 75%, and annualized returns have been roughly the same. However, TIPS outperform gold on a risk-adjusted basis. 

Views from the street

One of the best analysts in the markets, UBS Precious Metals Strategist Joni Teves, says gold's sharp correction reflects the frothiness of the market. She believes a healthy consolidation should be good for the market in the long run and expects strategic players to take advantage of this setback to continue building long-term positions.