With more geopolitical-related re-positioning stealing the spotlight on Mar. 1, Brent and WTI surged, and the PMs spiked higher as well. However, while the short-term implications haven’t been beneficial, the recent rallies may be nearing their end.
For example, when crises erupt, investors follow a familiar playbook. With another re-enactment on full display, the unwinding of these positions will likely have a drastic impact over the medium term.
The blue line above tracks investors’ positioning in global safe-haven assets. For context, the basket includes risk-off currencies, bonds, and, of course, gold. However, if you analyze the right side of the chart, you can see that the dark blue line is roughly two standard deviations from its average.
As a result, the implied probability of further bullish positioning is roughly 2.5%. Quite a huge contrast from the "100% certainty" that gold soars during wartime that we see in some internet forums, isn’t it?
Furthermore, if you focus your attention on the low points witnessed over the last ~10 years, investors’ current positioning in safe-haven assets has surpassed the peak that materialized during the Russia-Ukraine conflict in 2014 (follow the horizontal red line above).
On top of that, if you analyze the pink vertical bar on the right side of the chart, you can see that Vanda Research’s geopolitical risk index has hit a roughly 10-year high. As a result, fear is abundant, and investors use safe havens as a short-term hiding spot.
However, over-positioning in safe-haven assets nearly always leads to sharp reversions once sentiment shifts. Thus, if history is any indication, we may have already seen peak fear, and a re-allocation away from these assets will likely sink the PMs.
For context, I’ve presented the chart below on numerous occasions. However, if you compare investors’ positioning in global safe-haven assets in 2014 to where we are today (again, follow the horizontal red line above), you can see that the current reading has surpassed the peak from when Russia annexed Crimea in 2014.
Furthermore, if you compare the data with the chart below, you can see that peak safe-haven flows in 2014 coincided with peak gold. As investors’ positioning in global safe-haven assets reverted toward neutral from 2014 to 2015, the yellow metal sank like a stone.
As such, considering that the z-score implies a ~2.5% probability of further bullish positioning ahead, it means that there is a ~97.5% chance that safe-haven bets decelerate from here. With gold suffering mightily during the 2014 unwind, is this time really different?
If that wasn't enough, the Fed's next monetary policy meeting is on Mar. 15/16. While investors remain distracted by the Russia-Ukraine conflict, officials aren't backing off their hawkish rhetoric.
For example, Fed Governor Christopher Waller said on Feb. 24 that "it is possible that the state of the world will be different in the wake of the Ukraine attack, and that may mean that a more modest tightening is appropriate."
However, with Russia accounting for less than 2% of global GDP and the U.S. only levered to Russian oil, Waller said: "I believe appropriate interest rate policy brings the target range up to 1% to 1.25% early in the summer," and that selling assets on the Fed's balance sheet should occur "no later than" the July meeting.
Furthermore, if inflation outperforms when the data is released on Mar. 10, Waller said that a 50 basis point rate hike could be appropriate.
Source: Bloomberg
Echoing that sentiment, Atlanta Fed President Raphael Bostic said on Feb. 28:
"I am still in favor of a 25 basis-point move at the March meeting."
However, he added:
"every meeting is live for us. As data comes in, we will have to make judgments about what happens at every stage of the way.
"Historically, over the last 10 years or so our moves have been in 25 basis point increments. I was hearing and getting a sense that many expected that was the only type of move we could do. I actually think that is wrong. We need to make sure people have different levels of move in mind, and awareness of those are possibilities."
As a result, if inflation remains elevated, Bostic also said that a 50 basis point rate hike in March is a possibility:
Source: Bloomberg
To that point, if the Fed wants inflation, it doesn’t have to look very far. For example, the S&P Goldman Sachs Commodity Index has rallied by nearly 27% year-to-date (YTD). For context, the S&P GSCI contains 24 commodities from all sectors: six energy products, five industrial metals, eight agricultural products, three livestock products and two precious metals. However, energy accounts for roughly 54% of the index’s movement.
Moreover, with the Russia-Ukraine conflict intensifying the supply shortages, the inflationary impact is material.
Second, IHS Markit released its U.S. manufacturing PMI on Mar. 1. While the headline index increased from 55.5 in January to 57.3 in February, and "less severe supply disruption was reflected in a slower increase in input prices," the data was compiled before Russia invaded Ukraine. As a result, with the S&P GSCI going vertical in recent days, input prices will likely accelerate next month.
Furthermore, the short-term slowdown in input prices didn’t stop businesses from raising their output prices.
Source: IHS Markit
To that point, Chris Williamson, Chief Business Economist at IHS Markit, said:
“Demand is clearly continuing to run well ahead of supply, meaning it is a sellers’ market for a wide variety of goods. Although the survey’s price gauges covering companies’ costs and selling prices are off the peaks seen last year, they remain very high by historical standards and point to persistent elevated inflation in coming months. With rising oil prices adding further to soaring costs, and the Ukraine crisis likely to add to global supply disruptions, the inflation outlook is an increasing concern.”
Speaking of demand, the report revealed:
"Increased new order inflows spurred greater optimism among manufacturing firms in February. Output expectations for the coming year were the strongest since November 2020, as firms were buoyed by hopes of a reduction in supply-chain disruption and a greater ability to retain employees."
Finally, the Institute for Supply Management (ISM) also released its Manufacturing PMI on Mar. 1. Showcasing similar strength, the headline index increased from 57.6 in January to 58.6 in February. Moreover, while pricing pressures calmed somewhat from last month, Timothy R. Fiore, Chair of the ISM Manufacturing Business Survey Committee, said:
"The U.S. manufacturing sector remains in a demand-driven, supply chain-constrained environment. The COVID-19 omicron variant remained an impact in February; however, there were signs of relief, with recovery expected in March. A higher-than-normal quits rate and early retirements continued. Panel sentiment remained strongly optimistic, with 12 positive growth comments for every cautious comment, up from January's ratio of 7-to-1."
As a result, U.S. economic growth remains resilient, and all of the metrics tracked by the ISM are pointing in positive directions.
Why is this so important?
Well, because it keeps the pressure on the Fed. With growth and inflation outperforming their pre-COVID trends, the Fed has little reason to perform a dovish 180. Moreover, with the Russia-Ukraine conflict only exacerbating the pricing pressures, the Fed is running out of time to act. In addition, it was only four months ago that the idea of a rate hike in March was ridiculous. Now, some Fed officials are debating whether 25 or 50 basis points are appropriate.
Thus, while the PMs remain distracted from the more important fundamental development, the situation is unfolding exactly like in 2014. As a result, while it’s unclear when sentiment will shift, history implies that when it does, safe-haven positioning and the fundamental backdrop should be extremely unkind to the PMs.
In conclusion, the PMs rallied on Mar. 1, as investors remained sensitive to every Russia-Ukraine headline. However, with one-sided safe-haven bets surpassing the splurge from 2014, the medium-term unwind will likely culminate with crashing precious metals prices. As a result, while the short-term environment remains challenging, sentiment should look a lot different in the coming months.