With another dire warning from the White House uplifting gold and mining stocks on Feb. 11, Russia and Ukraine's “will they or won't they” saga has shifted sentiment. However, it's important to remember that geopolitical risk rallies often have a short shelf life and dissipate over the medium term.
To explain, I wrote on Sept. 21:
"When terrorists attacked the World Trade Center roughly 20 years ago, gold spiked on Sep. 11, 2001. However, it wasn’t long before the momentum fizzled and the yellow metal nearly retraced all of the gains by early December. Thus, when it comes to forecasting higher gold prices, Black Swan events are often more semblance than substance."
As further evidence, when Russia annexed Crimea from Ukraine in 2014, similar price action unfolded. For example, when rumors swirled of a possible invasion, gold rallied on the news. Then, when Russia officially invaded, the yellow metal continued its ascent. However, after the short-term sugar high wore off, bearish medium-term realities confronted gold once again. In time, the yellow metal gave back all of the gains and sank to a new yearly low.
Thus, while conflicting reports paint a conflicting portrait, the medium-term algorithms don’t care whether Russia invades Ukraine or not. With the rumor enough to pique investors’ interest, quantitative traders see it as an opportunity to capitalize on the momentum. However, once that momentum fizzles, history shows that the quants rush for the exits. As a result, is this time really different?
Let’s keep in mind that the above assumes that Ukraine would indeed be invaded, which, in my view, is unlikely, despite news coming from the White House.
To that point, the USD Index is also a major beneficiary of geopolitical tensions. However, in contrast to gold, the greenback’s rally on Feb. 11 aligns with its medium-term fundamentals.
To explain, while the EUR/USD has been in style in recent weeks, ECB President Christine Lagarde provided another dose of reality on Feb. 11. Speaking with Redaktionsnetzwerk Deutschland, she reiterated all of the points that I’ve been making for months. For example, when asked about inflation and why the ECB hasn’t raised interest rates, she responded:
"Hold on! We first need to understand the source of the rise in prices. Just over 50 per cent of it can be attributed to the surge in energy prices. oil, gas and electricity have become more expensive. And as we import a lot of energy, these prices are, to some extent, beyond the sphere of influence of our economy."
She added:
"The second main factor driving up prices is supply bottlenecks: shortages of microchips, container jams, disrupted supply chains. Let me ask you: what can the ECB do about that? Can we resolve supply bottlenecks? Can we transport containers, lower oil prices or pacify geostrategic conflicts? No, we can’t do any of that."
As a result, while euro bulls continue to hope for a hawkish shift, Lagarde threw cold water on that idea.
Source: ECB
For context, I wrote on Feb. 8:
"While the EUR/USD held on to its ECB-induced gains, the bearish fundamental realities confronting the currency pair were confirmed on Feb. 7. To explain, while euro bulls think that the ECB will have a hawkish awakening, I warned on Feb. 4 that the prospect is much more semblance than substance.
"Investors have priced in two ECB rate hikes in 2022. However, with the central bank still planning to purchase bonds “from October onwards” and Lagarde saying that rate hikes will only be considered thereafter, short-term sentiment should crumble over the medium term."
If that wasn’t enough, Lagarde also highlighted the U.S.-Eurozone fundamental dichotomy that I warned about throughout 2021.
Source: ECB
What’s more, ECB Governing Council member Olli Rehn echoed her sentiment on Feb. 11. He said:
"If we reacted strongly to inflation in the short term, we would probably cause economic growth to stop. It’s better to look beyond short-term inflation and look at what inflation is in 2023, 2024."
As a result, while the ECB continues to disappoint euro bulls, the reality is that the Eurozone fundamentals have never changed. I’ve highlighted on numerous occasions that oil and gas are the main drivers of Eurozone headline inflation, and more importantly, core inflation actually declined in January. To explain, I wrote on Feb. 4:
Source: Eurostat
"Follow the trajectory of the red rectangle above. As you can see, headline inflation (which includes food and energy) went from a 0.9% year-over-year (YoY) increase in January 2021 to a 5.1% YoY increase in January 2022. Pretty troublesome, huh?
"However, if you focus your attention on the green rectangle, you can see that Eurozone core inflation (which excludes food and energy) declined from 2.7% YoY in December 2021 to 2.5% YoY in January 2022. As a result, while investors assume that abnormally high headline inflation will elicit a hawkish response from the ECB, the reality is that oil & gas remains the region’s only problem."
On the flip side, while the USD Index has suffered in recent weeks, Bank of America told clients that the Fed should win the "race to the top" when it comes to interest rate hikes.
"USD is no longer broadly perceived as having a strong monetary policy tailwind behind it. We disagree, less with the impulse to re-price global central banks (CBs) higher, and more with the failure of markets to preserve the Fed's lead," said Ben Randol, G10 FX & Rates Strategist.
As a result, Bank of America expects the EUR/USD to hit 1.10 in 2022.
Source: Pound Sterling Live
Furthermore, RBC Capital Markets expects the EUR/USD to fall below 1.10 in 2022. Strategists wrote:
"The question is whether late January marked the bottom for EUR/USD and we will stay at higher levels (end-2022 consensus is 1.14) or it will prove to be another false dawn and EUR/USD will make new lows. We are still in the latter camp."
The bottom line? While gold often outperforms in the short term when geopolitical tensions rise, history shows that the momentum fades over the medium term. Moreover, with the recent rally contrasting gold’s bearish medium-term fundamentals, the ascent sets the stage for an even harder fall over the next few months. As a result, while the quants may “buy the rumor,” it’s often a mad dash for the exits once sentiment shifts.
As the Ukraine-related tensions subside as there’s no attack (in particular, there’s no attack this week), the precious metals market could start its decline quite soon.
In conclusion, the PMs were mixed on Feb. 11, and mining stocks outperformed. However, while the headline risk may seem monumental, fundamental factors like the USD Index and U.S. Treasury yields will hold more weight in the coming months. As such, the recent strength is likely a countertrend rally, and lower lows should confront the yellow metal over the medium term.