Gold’s battle with bonds and the dollar- the Algo impact

GOLD is struggling to bottom out but the key will be the course of bond yields, and the US dollar. Much will depend on whether algorithmic funds change course.

Investment advisers have long described gold as a safe haven, but recent events have once again shown that the metal can hardly be regarded as “safe”.

Following a boom in 2019 and the first few months of 2020, gold has experienced an acute bear market since it peaked at US$2,074 an ounce in August last year.

The price slumped by 21 per cent to a low of US$1,678 at the end of March 2021. The downturn is ironic as the thesis of many a gold bull was that stock markets would slump and gold would benefit.

Instead, the opposite happened. Illustrating the disenchantment, holders of gold exchange traded funds (ETFs) sold when gold tumbled to its lows in March. This offloading was in the fourth month out of five, according to the World Gold Council (WGC). Global gold ETFs assets under management have fallen from a peak of 3,880 tonnes in the third quarter of last year to 3,574 tonnes (worth about $194.5 billion) at the end of the first quarter of 2021, according to the WGC.

In recent days, gold has recovered by around 5 per cent and similar trends have been evident with silver and platinum.

After touching $1,790 on April 19, gold has dipped to $1,768 an ounce. Gold bulls who tend to mouth their views on Kitco, a gold and mining website, are hopeful that the price performance indicates that the metal is at last bottoming out.

Gold shares which had slumped about 30 per cent from 2020 peaks to lows, despite surging profits, have led the minor recovery from March 2021 lows. Gold mines have high operational leverage and the better mines have costs of $800 to $1,000 an ounce. Thus at current prices their profit margin is a whopping $700 plus. Since cash flows are well up, they are raising dividends. But despite that, GDX, the Van Eck Gold ETF is languishing at levels of April/May last year when bullion was $1600 to $1700 an ounce.

Algorithmic funds’ impact on the gold market

Regardless of the views of gold optimists or pessimists, much depends on the models of algorithmic funds, said Ross Norman, an experienced bullion trader, who is now the chief executive officer of Metals Daily, a niche publication. “Gold tends to slavishly follow important threads and themes, and the idea of using programmes to trade markets has been around for years.”

Algo funds apply computer programs that follow specific instructions based on momentum, interest rate and economic models. The most basic model is to buy or sell when the financial asset breaks through moving averages or pivotal chart points. The Bank For International Settlements recently estimated that some 30 per cent of foreign exchange volumes comes from algo trading. Some unconfirmed estimates place the equity market algo trading proportion at 70 to 90 per cent. There are also mainly computer driven trading in commodities. The founders of these systematic models include Winton Capital Management followed by Man Group’s AHL fund.

“It now no longer matters that the underlying narrative may have changed, nor that the basic premise is past its sell-by-date; momentum and trend-following algos will ensure the direction of travel,” Mr Norman said.

The current fashion, which is embedded in algo models, is the direction of nominal bond yields. Rising bond yields are regarded as negative for gold and flat or falling yields, positive. The reasoning is that investors will sell gold because it doesn’t pay interest. The US dollar can, but not always, follow the direction of bond yields.

Since the international price of gold is denominated in US dollars, a declining greenback tends to be bullish for gold and vice versa. A strong dollar makes the metal more expensive for buyers from countries such as India, China and in Europe.

According to Mr Norman, gold’s inverse relationship with the 10-year US treasury yield has risen from 32 per cent in 2017, to 59 per cent in 2018, 91 per cent in 2019, 95 per cent in 2020 and 88 per cent in the year to date.

Between 2018 and the first half of 2020, gold prices rose as bond yields fell and since then have fallen while bond yields have risen.

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A reason for the slight recovery of gold is that 10-year US treasury bond yields have stabilised around 1.6 per cent following US Federal Reserve chairman Jerome Powell’s dovish comments at a recent panel discussion organised by the International Monetary Fund. He said that the US economic recovery would be uneven and that the Fed would continue to buy bonds to keep rates down.

The majority of investment bankers and precious metals advisers have maintained their bullish stance on gold, although most have lowered their optimistic August 2020 predictions of $2,500 to $3,000 an ounce. A few others such as Citibank are predicting further lows. Clearly the course of the global economy and yields will be the key.

The bulls reason thus: US President Joe Biden is reflating the US economy with trillions of dollars, with European nations, Japan and others doing the same. China, however, has become more conservative, according to Simon Hunt Strategic Services.

Moreover, global debt has soared during the pandemic and the gold bulls feel that central banks around the world will do their utmost to maintain lower interest rates in order to keep repayment costs down.

In the 1970s and beginning of the Millennium gold rose despite sharp interest rate rises

So far, the experts have badly misjudged the gold market as they failed to recognise that economic recovery and expectations of higher inflation bring in their wake rising bond yields.

In the 1970s and beginning of the millennium, however, gold continued to rise despite sharp increases in both short term interest rates and bond yields. At that time, inflatiion was accelerating rapidly. So far, the models of the algo funds have not taken this into account. Only a firm trend change will likely change their bearish stance, said Mr Norman, adding that he predicts this could take place in the second half of this year.

© Neil Behrmann. This article was first published in The Business Times Singapore . For other Asian and global articles try https://subscribe.sph.com.sg/publications-bt/

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