There is never a wrong time to take profit, but I suspect after 72 consecutive hours of the gold market going parabolic where the weak hand was arguably overbought. Fast money traders finally emerged on Friday to fade the gold rally into the Nonfarm Payrolls report, which likely triggered as cascading of profit-taking from long-time holders of gold, say from USD1,400-1,600/oz that may find this an attractive place to take profits.
But life in the gold lane may very much depend on the course of the US dollar and its safe haven propensities. The USD has spent most of the COVID-19 pandemic as a" safe haven," moving inversely to equity markets. The bad news was generally good news for the USD.
It also supported gold, which may explain why gold and the USD frequently moved up together earlier in the year. But the propensity for gold and the dollar to move in unison has lessened as the quaint simplicity of the counter cycle dollar has shown signs of weakening in July where the dollar has reacted favorably to more robust US economic data.
Gold and silver pulled back on Friday but ended the week up sharply higher. The flight path for gold, which has been almost parabolic, infers some correction was possible.
President Trump's executive order limiting business with Chinese-owned WeChat and TikTok apps, initially lent some support to bullion, but then the gold sell-off started in Asia despite a weaker equity market which was unable to underpin gold as perhaps the massive write-down on the widely held Tencent (HK:0700) may have triggered some gold selling in Asia to cover margins. Still, on balance, gold prices were relatively steady in both Asia and Europe.
The big move lower came in US trading hours
The big move lower came in US trading hours. A slightly better-than-expected US jobs report lent strength to the USD, which weighed on gold.
Gold initially fell on better-than-expected US jobs data as the algorithms ran roughshod over the NFP payroll report black boxes in Secaucus NJ were notable buyers of dollars and sellers of gold on the Nonfarm Payrolls print. And with word circulating that producer may be in hedging, this probably compounded matters as 100,000 ounces of selling outpaced demand into the LBMA fix as traders nudged the price lower at $2,031.15 an ounce in the afternoon auction. Prices then fell further exacerbated by retail selling as most unsuspecting traders were unsure why gold was falling other than a slightly firmer USD dollar, which reprices gold lower because gold is priced in dollars.
Other than the algos, I am not sure who was actually buying dollars on the NFP prints. Let us face it the days when robust US economic data will change the Fed policy perspective are gone as data "beats" will surely not change the fed funds outlook anytime soon. Yes, it will take away some of the urgency from additional Fed measures like yield curve targeting, but that is much less of a big deal with real yields where they are.
How Quants influence NFP trading (gold and the US dollar)
From the quant trading economic headline perspective view, the NFP did become a tradable spike event, so the black boxes in New Jersey were fired up for the first time in months over an NFP.
Let me try and bring some gravity to the discussion as I explained to my followers on Twitter Friday pre-NFP as to how to configure your headline trading algorithm.
It was striking to see the NFP standard deviation of expectations had narrowed sharply, down to 820k. That is still quite a lot, but compared with 1.5 mn, 2.4 mn, and 3 mn for the last three prints, it is noticeably narrower. Which means the gap for a positive/negative surprise should be lower. The weak hand was arguably overbought gold and oversold US dollars, and + 400 (1.84 NFP print) delta to expectation would hit the EURUSD -40 to -50 pips, and a +800 delta (2.2 NFP print) could run the EURUSD -50 to -100 pips. And gold would fall exponentially. Like my month-end trading strategies on the Pound, these simple pin the tail to the FX donkey trades get executed month in and out when the conditions suit.
More pretzel logic
The Fed has made it clear policy will be accommodative for some time, giving fixed income a strong anchor, and negative real yields feel like a more significant driver for gold. Still, even that anchor slipped on Friday as the stronger dollar hurt the price of commodities.
But the market pretzel logic was in vogue still on Friday. Investors had been piling into gold to hedge against a rise in US-China tensions only to see commodity traders unfortunate predisposition to heightened US-China trade tensions which caused them to sell commodities and oil which saw real interest rates—which strip out the effects of inflation—rise by the most in a month Friday. Which ultimately ended up weighing on gold.
Gold and the dollar
For the most part, the DXY is getting driven by the euro, where USD/Asia has been the laggard, and as I continuously remind folks when it comes to opening the door to dollar weakness, it takes two to tango.
But history also suggests when it comes the euro, levels are critical and as I had recently been concerned that the EURUSD bounce was not a eurozone equities inflows thing, but that maybe it is better to think of this EUR strength more as a reduction in the existential risk premium or increase in European unity rather than an inflow story.
When traders start thinking about moving into a new breakout channel, say 1.20-1.25, growth differential most certainly counts, and I believe this is why the US dollar is beginning to lose some of it pretzel logic appeal as the US economic data is much stronger than expected. However, this does not mean that long USD is the trade, but it probably means short USD will not be as fun for the next few weeks as it was for the last few, suggesting gold may need to compete with the dollar over the short term.
Amber lights over the short term
Not everything asserts for higher gold. As mentioned earlier, chatter that producers may increasingly take advantage of prices, far more than the highest marginal mine costs, to sell forward. Longer-term holders of bullion from hundreds of US dollars below the market may continue to take profits. The market got a further bounce as strike prices at USD2,000/oz, USD2025/oz, and USD2,050/oz were triggering short covering. But this has already occurred, and the market fell well short of challenging the USD2,100/oz, mark, so there may not be much more fresh buying from this quarter especially with US Treasury yields trading firmer on the back of better US economic data, as traders are again thinking the end of the runway for lower actual yields is nearing. With that in mind, it might be up to real returns to the bulk of the heavy lifting so that the oil market will be back in focus over the near term. Higher oil prices raise inflation. break evens more favorably for gold
Gold has yet to challenge previous highs in real terms, either 2011 high adjusted for CPI (USD 2,159/oz), or the all-time of USD 2,805/oz in real terms. While it is not out of the question gold can reach 2300-2500 this year, the most prominent risk to gold is nominal risk-free yields moving higher. That is not to say gold can not move higher if nominal yields flatline of move slightly higher from current levels; it just means the load falls on other factors to enhance gold from a bullish perspective.
To get the gold smelters working in overtime and add jet fuel to the rally, the Fed may need to accelerate asset purchases, which would provide a higher level of policy accommodation and could weaken the US dollar. Or additionally, there is a normalization in inflation break-even toward 1.75%-2.0% (commodities higher), which would be complemented by the adoption of average inflation targeting, which a majority of Fed officials endorse. Not unreasonable, but we are not there yet.
Subdued physical demand in the east is offset by ETF buying
The gold rally in 2020 is unequivocally driven by macro factors rather than supply and demand fundamentals that may be driving other commodities higher due to supply chain disruptions. Negative and falling real rates, a weaker dollar, elevated geopolitical uncertainty and the exorbitant cost to repair the damage done from Covid19 has seen the Federal Reserve and US government's balance sheet grow to incredulous proportions creating an extremely a favorable for the gold environment for encouraging a wide range of investors to build strategic gold allocations.
As such, it is not surprising that prices are up over 34% YTD despite sharp declines in gold consumer demand in the form of jewelry, dentistry and bars, and coins. Gold ETFs globally has increased by over 27m oz. Not only is investor interest growing, but the base is expanding exponentially.
However, with a growing demand for physical settlement of futures contracts investors appear to be using gold futures to get long physical, The current level of gold hoarding behaviors in the major NY hub is suggesting there is a possibility then that gold could see the opposite of what happened in crude oil earlier in the year amid problematic international travel and massive demand for physical delivery.