Expectations are high

Since June, the price of gold has risen steadily by over $250 per ounce to a six-year high of $1,557 on September 4, before spending the rest of September consolidating around the $1,500 level. The gold price found support on the 12th as the European Central Bank (ECB) merged with the US Federal Reserve (Fed) in a monetary reversal in ultra-loose monetary policy, announcing that it would resume bond buying that had ended nine months earlier. The ECB lowered the deposit rate to minus 0.5 percent and will buy 20 billion euros worth of bonds from November to avoid a recession in the eurozone. Gold was also supported by a missile and drone attack on a large Saudi oil refinery that paralyzed 5 percent of the world’s oil supply.

 

Consolidation on the horizon, but risks on the rise

Systemic risk emerged when the overnight buy-back agreement market lacked the liquidity to cope with the coincidence of a corporate tax payment and the settlement of a Treasury bond auction on 17 September. Banks refused to lend because open market interest rates tended to be as high as 10 percent, and the Fed was forced to inject billions of dollars into the financial system to ease the pressure. The post-crisis banking rules, the Treasury’s insatiable appetite for cash, and the Fed’s management of the trillions of dollars of securities on balance sheet led to unintended consequences that have been clarified for the time being. However, the question is how financial markets will behave under a less benign variety of systemic stress.

 

The price of gold was kept in check as trade relations with China eased somewhat when the two sides agreed talks in October. Gold faced further headwinds as the S&P 500 missed its all-time high by a hair’s breadth on the 19th and the US dollar index (DXY) tended to reach a new 28-month high on the 30th. We wonder who is investing in US assets amid all the impeachment chaos, systemic stress and fiscal irresponsibility. Perhaps the computers have really taken over.

 

The gold market was robust until September 30th, when the dollar strength seemed to crush the metal. We wondered whether an interim correction to the gold price would take place at $1,500 or higher levels. We now have the answer, as gold fell by $47.91 (3.2 percent) to $1,472.39 in September, and it looks as if October will turn into a month of correction. Gold also fell: The NYSE Arca Gold Miners Index (GDM) fell 10 percent and the MVIS Global Junior Gold Miners Index (MVGDXJ) 11.2 percent.

 

Gold continues to exceed expectations

The rally in gold prices this year has surprised most investors so far. There have been strong inflows into ETFs, but in practice we have seen few inflows into gold equity funds. For many, this movement dates back to the first half of 2016, when the gold price rose by $260 and the GDM doubled. However, the 2016 movement did not continue. Gold and gold stocks gave way and then barely moved for three years. Equity investors are now understandably cautious and hesitant to get involved. Now that the correction is on the move, it looks as if we will soon find out whether 2019 was another flash in the pan or the start of a new bull market. The macroeconomic environment today is much more supportive than 2016. Both the economic expansion and the general equity boom are now the longest since records began. Global growth is slowing fundamentally. Real interest rates have fallen and are likely to fall further for the foreseeable future. Negative-interest bonds have an astronomical 15 trillion worldwide. US dollar has reached and is rising. Global leadership seems to be getting worse and worse.

 

Before 2019, the upper resistance line for gold was 1,365 US dollars. As soon as the upper resistance is broken, it often becomes the lower support. Therefore, gold could fall to $1,365 in the current correction and still maintain a strong uptrend. It is also possible that gold could consolidate at higher levels, in the range of $1,400 to $1,450. This correction can take place within a month or continue until the end of the year. While we will only know the details afterwards, the strong macroeconomic drivers suggest that this correction will only be a ground wave and not the end of the line. Given gold’s performance so far this year, we will not be surprised if our expectations continue to be exceeded.