Studies on Gold and its relationship with other financial variables

One topic that has been making the headlines over the past couple of years is the central banks’ next step: helicopter money. As the effectiveness of monetary policy has decreased drastically since 2008, a new response to stimulate the developed nations’ economy and generate some inflation in order to deflate their debt would be to transfer money directly to the nation’s citizens. This money, as a contrary to Quantitative Easing or the central banks’ refinancing operations, will never be reimbursed. Therefore, an asset that reacted to more easing last year was Gold, which many academics and practitioners have called the ‘currency of the last resort’.

This study investigates the long-run relationship between gold and a complex of financial variables based on daily data from January 1990 to June 2016, then use this relationship as a fair value and see what sort of interpretation we can do with the results.

Link ==> cointegration-gold

Gold: how far can the current trend go?

Since the beginning of the year, the commodity market has been regaining strength, and especially gold that has been up 23% since its mid-December low (slightly below 1,050 USD/ounce). As you can see it on the chart below, the recent spike in commodities can be explained by the dollar weakness we have seen over the past five months (DXY index in yellow line inverted vs. Gold in candlesticks). However, I am still convinced that Gold could continue to act as the ‘currency of the last resort’ (i.e. an insurance against the confidence on the monetary system) even if the US dollar is set to appreciate in the long term.


(Source: Bloomberg)

As gold is traded primarily in dollars, many studies have showed that a weaker dollar makes gold cheaper and increases the demand for gold, which in the end pushes the price of the commodity higher. Therefore, Gold and US dollar should be negatively correlated. If we use HS spread analysis function in Bloomberg, we can see that the 1-month (20 Business days) correlation between Gold and DXY index (using the US Dollar index as a proxy of the dollar even if it’s mainly weighed in Euros, pounds and Yen) has been negative for most of the time over the past five years. However, this correlation can sometimes break down and turn positive for a small period of time.


(Source: Bloomberg)

The question now that I am asking myself is to know the positive correlation between US dollar and Gold can last longer than just a week or two.

The reason why I think Gold is set to appreciate in the long term is coming from a long fat tail risk list that gets very concerning. In it, we could find the following events:

  • Japanese crisis in the bond market
  • Banking crisis in China coming from a rise in NPLs and a housing market collapse
  • Corporate default rates soaring in the US high-yield market
  • European Banking crisis

If one of those ‘black swan’ events rises in terms of probability, we would then see a sort risk-aversion environment with more demand for safe haven assets, such as US Treasuries or US Dollars. At the moment, the 10-year and 30-year Treasury yields both trade at 1.74% and 2.57% respectively, and a sudden risk-off sentiment could push LT US yields close to zero.

Academic studies have shown that there exists a cointegrating relation between gold and US real interest rates. If we stick with the assumption that inflation will remain low (i.e. close to zero) in the medium term (2-year period) based on the market’s expectation and that Treasury yields start to crater ‘once again’, an interest for gold could be a good alternative.

Tactical view on XAUUSD

Based on the chart below, it looks like the 50 SMA (purple line) has been acting as a strong support, however the momentum could continue in the future. The next psychological level stands at 1,300 on the upside, any break out could lead towards 1,325 then 1,350. On the downside, I see a strong support zone between 1,220 and 1,250 and could be a good entry point for a long term investment. The risk is if the US Dollar starts to appreciate to quickly based on this week’s FOMC ‘hawkish’ minutes with the market now starting to price at least a couple of rate hikes for 2016. For those looking for a more ST investment, a good psychological support on the downside to set up your stop stands below 1,200.


(Source: Bloomberg)

Global Macro: trade on China’s weak signs and Draghi’s Will to Power

This article deals with a few current hot topics:

  • The main one gives an update on weakening signs of giant China
  • The second one reviews the ECB Thursday’s meeting, presented with a couple of FX positioning
  • The last one is on the debt ceiling debate and risk-off sentiment

China desperately flowing…

As I am looking at the current news in the market, there has been a lot of interesting topics to study over the past couple of months. I will first start this article with an update on China and its weakening economy. Since the Chinese ‘devaluation’ on August 11th, I have been focusing much more in the EM and Asian Market as I strongly believe that the developed world is not yet ready for a China & Co. slowdown. I heard an interesting analysis lately, which was sort of describing the assets that had performed since the PBoC action more than two months ago. As you can see it on the chart below, Gold prices (XAU spot) accelerated from 1,100 to a high of 1,185 reached on October 14th, and Bitcoin recovered from its low of 200 reached in late August and now trades at $285 a piece.


(Source: Bloomberg)

One additional explanation that I have for Gold is that I believe that the 1,100 level could be an interesting floor for long-term investors interested in the currency of the last resort. The weak macro, loose monetary policy, low interest rates and more and more currency crisis in EM countries will tend to bring back gravity in Gold, especially if prices become interesting (below $1,100 per ounce) for long-term buyers.

Looking at the CSI 300 Index, we still stand quite far from the [lower] historical high of 5,380 reached in the beginning of June last year. Since then, as a response, we had a Chinese devaluation, the PBoC cutting the minimum home down payment for buyers in cities last month (September 30th) from 30% to 25% due to weak property investment, and then a few days ago the PBoC cutting the Reserve Requirement Ratio (RRR) for all banks by 50bps to 17.50% and its benchmark lending rate by 25bps to 4.35%. Looking at all these actions concerns me on the health of the Chinese economy; it looks very artificial and speculative. In a late article, Steve Keen, a professor in economics explained that the Chinese private-debt-to-GDP ratio surged from 100% during the Great financial crisis to over 180% in the beginning of 2015, amassing the largest buildup of bad debt in history. Its addiction to over expand rapidly have left more than one in five homes vacant in China’s urban areas according to the Survey and Research for China Household Finance. Banks are well too exposed to equities and the housing market, and it looks that they have now started a similar decline as the US before 2008 and Japan before 1991. To give you an idea, the real estate was estimated to be at 6% of US GDP at the peak in 2005, whereas it represents roughly 20% of China’s GDP today.


(Source: Forbes article, Why China Had to Crash)

I wrote an article back last September where I mentioned that the Chinese economy will tend to slow down more quickly than analyst expect, therefore impacting the overall economy. We saw that GDP slide to 6.9% QoQ in the third quarter, its slowest pace since 2009 and quite far from the 7.5%-8% projection in the beginning of this year.

Draghi’s Will To Power

One fascinating event this week was the ECB meeting on Thursday. Despite a status quo on its interest rate policy, leaving deposit rate at -0.2% and the MRO at 5bps, a few words from the ECB president drove immediately the market’s attention. He said exactly that ‘The degree of monetary policy accommodation will need to be re-examined at our December policy meeting’, therefore implying that the current 1.1 trillion-euro program will be increased. As you can see it on the chart, EURUSD reacted quite sharply, declining from 1.1330 to a low of 1.0990 on Friday’s trading session, and sending equities – Euro Stoxx 50 Index – to a two-month high above 3,400. Italy 2-year yield was negative that day (hard to believe that it was trading above 7.5% in the end of November 2011).


(Source: Bloomberg)

 I am always curious and excited to see how a particular currency will fluctuate in this kind of important events (central banking meeting usually). One thing that I learned so far is to never be exposed against a central bank’s desire; you have two options, either stay out of it or be part of the trend.  I think EURUSD could continue to push to lower levels in the coming days, with the market slowly ‘swallowing’ Draghi’s comment. I think that the 1.0880 level as a first target is an interesting level with an entry level slightly below 1.1100 (stop above 1.1160).

USDJPY broke out of its two-month 119 – 121 in the middle of October down to almost 118, where it was considered as a buy-on-dip opportunity. It then levitated by 3 figures to 121.50 in the past couple of weeks spurred by a loose PBoC and ECB. The upside looks quite capped in the medium term if we don’t hear any news coming from the BoJ. The upside move on USDJPY looks almost over, 121.75 – 122 could be the key resistance level there.


(Source: Bloomberg)

Potential volatility and risk-off sentiment coming from the debt ceiling debate

On overall, with US equities – SP500 index – quietly approaching its 2,100 key psychological resistance with a VIX slowly decreasing towards its 12.50 – 13 bargain level, I will keep an eye on the debt ceiling current debate in the US, which could trigger some risk-off sentiment in the next couple of weeks (i.e cap equities and USDJPY on the upside). Briefly, the Congress has to agree on raising the debt limit to a new high of 19.6tr USD proposed (from 18.1tr USD where it currently stands). The debt limit is the total amount of money that the United States government is authorized to borrow to meet its existing obligations, and the current debt ceiling proposal’s deadline is November 3rd. No agreement would mean that the US government could default on its debt obligations, which could potentially increase the volatility in the market.

The chart below shows the increase of the debt ceiling since the early 1970s, after the Nixon Shock announcement which led to the end of Bretton Woods and the exponential expansion of credit.


(Source: The Burning Platform) 

Gold: a response to more easing

Following my latest article on the Fed’s situation and a potential QE4 announcement next year if the situation deteriorates, I thought that a little article on gold could complete my overall view. As many other investors, I am trying to figure out where is the final bottom of the commodity. With all this currency debasement happening (and even more to come), I was wondering if agents will start to once again consider it as the ‘real money’ or – such as GS Jeffrey Currie calls it – the currency of the last resort.

The chart below shows the weekly prices of Gold since the late 90s; as you can see it, one ounce of Gold is now trading at 1,132 slightly above its 50% retracement (1,086.56) from a local low of 251.95 reached in August 1999 and a high of 1,921.17 reached in September 2011.


(Source: Bloomberg) 

Even though many Gold experts are still bearish on the commodity forecasts with a first target at $1,050 per ounce, I am wondering if $1,100 is a good level to start buying as a long term investment. I understand that investors have considerably starting to lose interest as soon as they realized we were entering in a disinflationary-then-deflation area and that it was more interesting to be exposed to US bonds as real interest rates were increasing. As you know, Gold doesn’t distribute dividends or coupons (and also lacks the full faith and credit of most governments) and is only subject to capital appreciation. Hence, a good factor that can explain the majority of changes in gold prices over the past few years is indeed the changes in real rates.

However, if we considered the 2016 scenario of QE4 as a response to the EM meltdown, in addition to an all-in desperate Abe and Europe’s Great Depression, gold could potentially attract more and more buyers in this sophisticated period.

Quick review of Gold inventories figures

According to two main sources – Kitco and World Gold Council – there is 170,000 metric tons of ‘above-ground’ Gold (i.e. Gold that have been mined in all human history), which corresponds to approximately USD 6.8 trillion based on a spot value of 1,130 USD per troy ounce. If we look at the growth of the top central banks’ balance sheets over the past twenty years (see chart below), we can see than we have reached an historical high of more or less USD 16 trillion. Therefore, based on that information, we can easily do the math and conclude that the gold-to-monetary-base ratio stands now close to zero.


(Source: Bloomberg)

As you can notice on the chart above, we have now entered in a Central-Bank-money-printing area since the Great Financial Crisis and we are struggling to get out of it. As I described in my latest article, I believe that the Fed’s response to the EM crisis will be a QE4. Based on a statistical analysis, it is clear that this one will be less efficient that the previous ones; efficiency of QEs has a sort of logarithmic function until a point where there is no effect to the economy or even a negative effect to it. Therefore, new money into the system could trigger Gold prices to the upside as investors’ faith on central banks will be clearly reviewed on the downside.

Even though global annual gold mine production has risen to 3,000 tonnes in recent years (reported by the World Gold Council) compared to a 10-year production average of 2,700 tonnes, I don’t think it will add further pressure on the commodity price in the medium/long term. Especially now that we have reached a sort of unlimited-printing strategy. In addition, geopolitical pressures and macro conditions in some of the main producers (Australia, South Africa, Russia. see gold main producers in the map below) will slow and perhaps revert that trend in the coming quarters.


(Source: World Gold Council)

To conclude, my view is that we could see a market’s response to gold as a sort of alternative currency to hold while we try to get out of this monetary debasement. The five-year chart clearly shows a negative trend, but I will try to add some gold in my portfolio at around 1,100 USD as a long term investment (and hedge).


(Source: Bloomberg)

FOMC minutes review, what’s next for the Dollar-Bloc currencies?

Yesterday, the Fed released its minutes of the last FOMC meeting (March 18-19) and we saw that the US policymakers were less hawkish than expected, easing rate hike speculation. Despite the last two NFP good prints and unemployment rate standing slightly above the ‘once-to-be’ 6.5-percent threshold (6.7% in March), the recovery is still fragile according to Fed officials who surprised traders and investors by showing that the central bank was more supportive of keeping its Fed Funds rate at low levels (0-0.25%).The US Dollar index broke its support at 79.75 and is now trading at 79.40, boosting most of the currencies.

As you can see it below, the US 10-year yield (orange) eased by 7 bps to trade at 2.65%, pushing the price of Gold (purple) back to 1,320 and helping the Yen (green) to continue its ‘strengthening episode’. Since last Friday’s high of 104.12, USDJPY has depreciated by 2.4% and seems on its way to test its support at 101.20. At the same time, the 10-year yield is down 15bps from 2.80%.


(Source: Reuters)

Is there more room on the upside for the Dollar-Bloc currencies?

AUD: The Aussie continues its positive momentum with Australian March employment report smashing expectations of a 5K increase to print at 18,100 (Jobless rate edged down by 0.2% to 5.8%). The Australian Dollar is now trading above 0.9400, levels we saw back in October. I believe that the inflation figures coming up at the end of the month (April 23rd) will determine the stance of monetary policy and if Governor Stevens could threaten the market once again of a rate cut if he judges that the Aussie is ‘uncomfortably high’. If we have a look at the chart below, the last ‘Aussie recovery’ was stopped after a 10% increase when it hit its 200-Daily SMA at around 0.9750 with the RSI indicator (14 days, 30-70) showing an overbought signal. In the second recovery episode, the pair is up 9.3% since the end of January and seems on its way to test the 0.9500 level. However, the overbought RSI may have been perceived by traders as a good time to start shorting the pair.


(Source: Reuters)

NZD: The Kiwi also appreciated sharply against the greenback and is up 8.65% since the end of January, trading at 0.8700 (August 2011 level). The Reserve Bank of New Zealand raised its Official Cash Rate (OCR) by 0.25% at its last meeting in March after holding it at a historical low of 2.5% for three years. Traders have been looking at the Kiwi as an interesting buying opportunity after Governor Graeme Wheeler announced that he expected to ‘raise the benchmark interest rate to about 4.5% in the next two years’ in order to curb inflation. Moreover, the unemployment rate declined to a 5-year low of 6.0% in the last quarter of 2013, while the economy expanded by 3.1% (down from 3.5% in Q3) and NZ’s current account deficit narrowed to NZD 7.55bn (or 3.4% as a share of GDP) through the twelve months through December (lowest ratio since Q1 2012).

The RBNZ will probably leave its OCR unchanged on April 23rd, which could hurt the Kiwi in the short term as some traders will start considering to take profit after the sharp appreciation. I would stay aside of the Kiwi at the moment and wait for further reaction from RBNZ policymakers on the strong exchange rate. The next resistance on the topside stands at 0.8840, which is the pair’s all-time high (Aug 1st 2011).


(Source: Reuters)

CAD: The surprise came from Canadian macroeconomic figures that completely reverse the bearish trend on the Loonie against the greenback. In its last meeting back in January, Bank of Canada lowered its inflation forecast stating that it expected the total inflation rate to remain at 0.9% in the first half of 2014, down from its previous forecast of 1.2%. As policymakers stated that they expected inflation to remain ‘well below target’, Governor Poloz turned the monetary policy to a dovish stance and the market was starting to price in a rate cut in one of the following meetings (currently at 1% since September 2010). However, the sudden increase in CPI (from 0.7% in October to 1.5% in January, then 1.1% in February) in addition to the better-than-expected indicators (GDP figures, Retail sales, Trade balance, Employment report…) brought back traders’ interest on the Loonie.

However, I think that the bearish trend on USDCAD is coming to its end and I will see 1.0800 as a good level to start buying the pair for a bounce back towards 1.1000 at first. USDCAD broke it 100-daily SMA yesterday (1.0900) and found support at 1.0850; technical indictors RSI is starting to show some oversold signals therefore some investors will see the 1.0800 – 1.0850 range as a buying opportunity.


(Source: Reuters)