Political and Economic Uncertainty Drives Gold to New 2014 High

Last week’s analysis that gold might have reached a peak at 1,355$/oz was premature. On Wednesday, March 12, spot gold broke through the resistance at this level and rallied further to 1,387$/oz.

One of the arguments for a peak was the divergence between gold and silver the week before. However, silver also rallied and pared the loss of the first week in March. But silver did not manage to rally stronger than gold, thus, it performed worse than gold. The PGMs even declined last week, which is a clear indication that it was not a broad flow of funds, which lifted gold above the resistance at 1,355$/oz.

The euro strengthened further against the US dollar, which was another factor for the positive performance of gold. Some members of the ECB council dampened further hopes for more monetary stimulus. This lifted the euro to almost 1.40 against the US dollar. The ECB expects growth to pick up, nevertheless, it revised its inflation forecast lower. However, the risk for GDP growth in the Eurozone is more biased to the downside than for positive growth surprises. Thus, also the risk for the ECB inflation forecast is higher for further falling inflation rates, which implies that the deflation risk would increase. The ECB might be at the brink of repeating the policy mistakes made by the Bank of Japan by waiting too long. Therefore, over the medium-term horizon, a further step to ease monetary policy remains still the most likely scenario.

In mid-January, the gold holdings of the SPDR Gold Trust ETF had reached a low 789.6 tons and recovered slowly towards the level at the end of last year. Since then, the gold holdings hovered around the 800 tons level. However, last week, gold holdings jumped by 1.4% to 816.6 tons. After having bottomed out at 22,691 contracts in early December last year, the net long position in gold futures held by large speculators rose to 118,890 contract on Tuesday, March 11, according to the recent CFTC report on the “Commitment of Traders”. This development clearly indicates that institutional investors increase again their exposure in gold. But what is the reason behind this move?

First, it is the geo-political development in the Ukraine and in particular at the Crimea peninsula. Since the start of this year, tensions in this region had an impact on stock markets. Initially, it was only on some days depending on the news flow. However, since the revolt on February 21/22 leading to the installation of a new administration, the situation escalated. Announcing sanctions by the US and the EU against Russia increased the nervousness among stock market investors. In each stock market report this week, the geo-political tensions between the West and Russia concerning the Ukraine were mentioned for the weakness of international stock markets.

The second factor, but probably more important, was the economic data released in China,  which revived fears that the Chinese GDP growth might fall below the 7.5% targeted by the government. It already started over the weekend, when the Chinese Custom Office released the data for the trade balance in February. Instead of an export surplus of $13.2bn as expected by economists, the trade balance swung to a deficit of $23.0bn as imports rose far stronger than exports. While the trade data is still reported on a monthly basis, China’s National Bureau of Statistics changed the procedure for industrial production figures. The output data for the first two month of the “Western” calendar year are reported together for February, which is due to the variable Chinese Lunar New Year holidays. For the first two months, industrial production increased by 8.6% over the same period in 2013, while the consensus predicted only a small decline of the annual rate of change from 9.7% in December to 9.5%. The weaker than expected economic data out of China weighed on stock markets as investors fear a slow-down of global economic activity.

Therefore, we come to the conclusion that it is the uncertainty about political and economic developments, which led to a new risk assessment of international stock markets. In 2013, institutional investors shifted funds out of precious metals into stock markets due to higher expected returns in equities, while the risk for a set-back in precious metals increased. Now, investors estimated that the risk for a correction in stock markets has risen and expected returns declined after the rally in many stock markets last year. Thus, gold is currently profiting as one of the safe havens in times of increases uncertainty.

But this fear among investors might not be justified. We have developed a set of macroeconomic indicators for various stock market indices, including the S&P 500 index, the Japanese Nikkei 225 index and various European countries. All these indicators still favor long positions in the corresponding stock markets based on the national economic data.

Gold and silver currently profit from uncertainty and a re-assessment of the risk-return relationships of international stock markets. Thus, gold cold rise to the 1,450$/oz mark, which we predicted as the high of gold in 2014 (see for example in the LBMA analyst forecast survey). However, for a push higher, the economic fundamentals would have to deteriorate and stock markets would have to correct further.