This article was written by Ipek Ozkardeskaya, Senior Market Analyst at FCA regulated broker London Capital Group Holdings plc (LON:LCG).
Gold traders strengthened their long positions through the month that ended February 17th, despite the significant rise in hawkish Federal Reserve (Fed) expectations.
The worldwide gold ETF holdings rose by 2.4% in one month.
SPDR, the world’s biggest ETF (Exchange Trade Fund) which holds 46% of total gold held in ETFs, increased its net long gold position by 4% over the month to February 17, as iShares (11.1% of market share) and Deutsche Bank (2.9% of market share) enlarged their earnings by 1.3% and 3.9% respectively over the same period.
Major ETFs kept their gold holdings steady last week. Even though some took profit on part of their allocations after FOMC Chair Janet Yellen signalled at her semi-annual testimony in Washington DC, that the Federal Reserve (Fed) will continue raising rates in 2017, many are expected to stay positioned on the bullish side of the market.
In theory, higher US yields are detrimental for gold.
As of today, the Fed is expected to raise rates two to three times through 2017. By 2019, Janet Yellen predicts 3% total increase in the US interest rates.
Usually, higher interest rates weigh on gold prices, as traders prefer investing in interest bearing products rather than non-interest bearing gold.
This was the rational behind the decline in gold prices after Donald Trump was elected President of the United States. In fact, Trump’s victory revived the hawkish Fed expectations and the prospects of a steeper interest rate normalisation pulled the price of an ounce 16% down to $1123 on December 14th.
Since then, gold recovered nearly $20 although the Fed hawks came increasingly in charge of the market.
Gold recorded three straight weeks of gains on the run up to February 17th and the overall feeling toward the yellow metal is on the rise. Why?
Several factors increase allure of gold.
Now that the higher interest rates expectations are majorly factored in the actual price of bullion, other factors are taken into consideration.
Rising inflationary pressures are positive for gold
Donald Trump’s victory in November presidential election significantly boosted the US’ inflation expectations. The US yields reacted immediately to Trump’s win. The US 10-year yields jumped to 2.60% in December from below 1.80% in the beginning of November. The US’ headline inflation advanced to 2.5% on year to January to give a solid backup to the rising inflation expectations.
Rising inflationary pressures encouraged fund managers to increase allocation in gold.
A historical parentheses
In the history, the US monetary base was pegged to gold.
The rising inflation required a greater amount of US dollars in circulation to avoid a significant decline in households’ purchasing power. For example, bread would cost $2 instead of $1, therefore requiring a greater nominal value of USD in circulation.
Meanwhile, the increasing quantity of US dollar in circulation required higher gold reserves. Therefore, at times of rising inflation, the price of gold would increase on the back of firmer central bank demand and would counter the decrease in the nominal value of $1.
Today, the US dollar is no longer backed by physical gold, yet investors still tend to increase their allocation in the yellow metal as a hedge against inflation.
Therefore, the rising inflation expectations wet macro-fund managers’ appetite in the yellow metal.
Hedge against the stock market volatility
Donald Trump’s victory triggered an unprecedented rally in the US stock markets. The Dow Jones and the S&P500 have been renewing records almost on daily basis since November 9, meanwhile the eventuality of a downside correction also increases along with the so-called speculative stock rally.
Gold is widely used as a hedge against the volatility in the stock markets. According to the CFTC data, the net speculative future long positions retreated below 100’000 contracts in December for the first time in a year, suggesting that there is room for a significant recovery in speculative gold positions as the conviction in the US stocks are increasingly at risk.
Political uncertainty is supportive of gold
The upcoming Dutch, German and French elections, as well as the unusual Donald Trump administration are expected to gradually increase the global political risks and enhance the inflows in the yellow metal.
Gold has potential to rise to $1300 by end of March
Based on our expectations of rising gold demand, we expect the gold market’s bullish trend to strengthen and to encourage a rise toward the 200-day moving average ($1262 at the time of writing), and the $1300 mark by the end of the first quarter of 2017.
In this context, price pullbacks could be interesting opportunities to reinforce gold allocations. Key mid-term supports are eyed at $1215 (minor 23.6% retracement on December 14 to February 7 rise) and $1198 (major 38.2% retracement).