Gold s role as portfolio diversifier resurfaces

Transcription

1 October 8 :AM GMT Gold s role as portfolio diversifier resurfaces Over the past moth gold has rallied by reachig its highest value sice July. The rally coicided with the stock market sell-off ad represets the retur of fear related demad for gold, i our view. But with US growth still strog ad rates still risig ca gold cotiue to act as a effective hedge? Firstly, we fid that fear is a more importat driver of gold ivestmet demad tha the opportuity cost of holdig gold measured by short-term US rates. Historically -year real rates have bee a good proxy of fear, but whe the Fed is hikig its sigal ca be distorted. Istead the market assessmet of the probability of US recessio becomes a more meaigful measure. Recessio worries have icreased recetly. Goig forward fallig uemploymet rate i the US ad cotiued trade tesios should keep these cocers elevated. At the same time, ext year our ecoomists forecast slowdow of US growth from.9 to. ad a pick-up of US core iflatio from. to.. This could make the US ecoomy look icreasigly like it is eterig late-cycle iflatio overshoot ad further support gold ivestmet. Aother bullish catalyst is growig iterest i gold by cetral baks drive by: the desire to diversify their holdigs; risig geopolitical tesios; ad the de-dollarizatio tred. Icreasig umbers of coutries are returig back to buyig gold for the first time sice 8-. Fially, our ecoomists expect EM dollar GDP to stabilize ad begi to grow agai, which should boost their gold demad through the wealth chael. But they highlight that trade tariffs, sactios ad policy actio create some short-term risks to the dowside. To sum it up, our framework suggests solid fudametals for gold. A low ad fallig US uemploymet rate combied with slowig growth ad risig iflatio should boost fear related DM gold demad. A reboud i EM dollar GDP icreases their gold demad through the wealth chael. O top of this, risig geopolitical tesios create upside risk to cetral bak gold demad. However, we also highlight some short-term headwids related to volatility i EM currecies ad the CNY i particular. We keep our, ad m forecasts at $/toz, $/toz ad $ but see upside risks oce US growth begis to slow. Mikhail Sprogis +()- mikhail.sprogis@gs.com Goldma Sachs Iteratioal Michael Hids +()-8 michael.hids@gs.com Goldma Sachs & Co. LLC Jeffrey Currie +()-8 jeffrey.currie@gs.com Goldma Sachs & Co. LLC Ivestors should cosider this report as oly a sigle factor i makig their ivestmet decisio. For Reg AC certificatio ad other importat disclosures, see the Disclosure Appedix, or go to

2 Gold s role as portfolio diversifier resurfaces Over the past moth gold has rallied by reachig its highest value sice July. The rally happeed o the back of the market sell-off ad spike i volatility. I our view it represets a reboud i fear-related demad for gold with ETFs begiig to build after several moths of declies (see Exhibit ). Durig the sell-off gold outperformed ot oly cyclical assets, such as equities, base metals ad oil, but also traditioal safe have assets such log-term bods (see Exhibit ). But with US growth still strog ad iterest rates expected to icrease further ca gold cotiue to act as a effective hedge? Exhibit : Gold ETFs rebouded as the market sell-off led to retur of fear Exhibit : Gold has outperformed both cyclical ad defesive assets over the past moth 9 Gold ETFs (lhs) VIX (rhs) Idex Cumulative returs sice October st Idex of - treasuries Equity Metals Eergy Jul 8 Aug 8 Sep 8 Oct 8 - / Oct / Oct / Oct / Oct / Oct / Oct / Oct 8 / Oct 9 / Oct / Oct / Oct / Oct / Oct / Oct / Oct / Oct / Oct 8 / Oct 9 / Oct / Oct / Oct / Oct / Oct / Oct / Oct - Source: Goldma Sachs Global Ivestmet Research, Bloomberg First, we fid that fear is curretly a far more importat driver of gold ivestmet demad tha the opportuity cost of holdig gold measured by short-term US rates. To measure ivestmet demad for gold we use et gold imports ito the UK, which is a proxy for wholesale ivestor demad for gold give the that LBMA vaults which store most of physical gold backig ETFs are located i Lodo. Lookig at Exhibits ad oe ca see that over time gold ivestmet has bee become icreasigly less sesitive to the federal fuds rate ad more tightly liked to fear captured by a assessmet of probability of US recessio risk. Oe possible reaso for this tred is gold ivestmet gradually becomig more istitutioalized especially post itroductio of ETFs i. Aother explaatio is the ed of the great moderatio a period of suppressed macro volatility ad low perceived systematic risks post 8 which made a larger share of global ivestors look at gold as a hedge agaist systematic risks. October 8

3 Exhibit : Ivestmet demad for gold has gradually become less sesitive to iterest rates ad... Exhibit :... more sesitive to chages i fear Lodo gold imports (lhs) Fed fuds rate (rhs) Lodo gold imports (lhs) US recessio probability (rhs) * * Professioal Forecasters' Probability of Declie i Real GDP, Quarters Ahead Source: Bloomberg, UK Customs Statistics Source: Federal Reserve Board, UK Customs Statistics We also examied the typical path of gold ivestmet durig the past hikig cycles. We fid that while o average Lodo gold holdigs ted to take a dip at the mid-poit of the cycle, they start buildig agai before the rate hikes are over (see Exhibit ). A likely explaatio is that as the rate cycle progresses ivestors become cocered that higher rates will lead to a growth slowdow ad buy gold as a hedge. This dyamic would explai why precious metals historically ted to icrease durig the rate hikig cycle (see Exhibit ) eve though its returs are weaker tha for base metals ad eergy (see Commodities shie whe the Fed hikes). Exhibit : Gold ivestmet teds to pause midway through the hikig cycle but begis to build agai before hikes are over Exhibit : I the past gold ad precious metals wet up durig period of rate hikes First hike... - m -m -8m -m -m -m Cumulative gold imports ito Lodo (lhs) Cumualtive rate hikes (rhs) m m m 8m m m m m 8m m m m m 8m m m m m Time (moths) Average Aualized Daily Returs Durig Fed Hikig 8 Idustrial Metals Eergy Precious Metals Livestock Agriculture Source: UK Customs, Goldma Sachs Global Ivestmet Research Historically we used -year real rates as a proxy of fear -related demad for gold as they were extremely sesitive to the risk-o, risk-off dyamic. But durig fed hikig periods -year real rates temporarily become a poor barometer of fear ad its correlatio with gold teds to fall sigificatly (see Exhibit ). This is because whe the Fed is hikig, log-term rates ca cotiue to rise eve if markets are icreasigly worried about growth due to tighter moetary policy. This oce agai suggests that the positive correlatio betwee log-dated US bods ad gold is primarily drive by their safe-have character rather tha a egative exposure to Fed Fuds rates. I fact durig the hikig cycle higher rates ca lead to weaker prices of risky assets (see The retur October 8

4 (agai) of the great rate debate) ad hece more fear (see Exhibit 8). This implies that util the hikig cycle eds the -year real rate correlatio with gold ca remai depressed ad we eed a alterative measure of fear. Exhibit : Correlatio betwee gold ad -year real rates teds to weake durig the hikig cycle Exhibit 8: As rates go up they ca lead to weaker prices of risky asset ad hece more Fear Fed fuds rate (lhs) Gold vs year real rate correlatio Correlatio US stock market vs. US bod correlatio US taper tatrum Equity/Bod m correlatio Curret R = US -year yields Source: Goldma Sachs Global Ivestmet Research Istead we thik that the market assessmet of the probability of US recessio is a more relevat measure of fear for gold ivestmet demad. Most recetly there has bee a spike i market worries regardig the possibility of a US recessio. These worries have i our view bee the primary reaso behid the reboud i gold ivestmet demad. The assessmet of recessio probability over the ext moths by a sample of professioal forecasters has icreased from to. Moreover, durig the recet market sell-off cyclical stocks uderperformed defesive sectors idicatig that cocers over US growth were oe of the primary drivers (see October Requiem). These cocers i tur were likely drive by the growig belief that US ecoomy is late cycle give how low the uemploymet rate is ad the potetial egative effects of trade wars o idustrial growth. While we thik that the US cycle still has room to ru it does t mea that markets will ot worry about it comig to a ed. I fact, goig forward we expect market fear of a US recessio to stregthe give our ecoomists expect the uemploymet rate to fall further (fuelig the late cycle arrative) ad trade tariffs are expected to remai beyod the US mid-term electios (see Exhibits 9 ad ad The Midterm Electio: Oe Moth to Go). Recessio worries ad gold ivestmet may icrease further after US growth begis to slowdow. Our ecoomists expect this to happe mid-ext year as the effects of fiscal stimulus begi to wear off. October 8

5 Exhibit 9: Fallig US uemploymet should cotiue to push market s assessmet of recessio risk higher Exhibit : Deceleratio of US growth i mid ext year should add to recessio worries 9 US recessio probability (lhs) * Uemploymet rate (rhs) GS forecast 8 US recessio probability (lhs) US growth chage (rhs, iv) * GS forecast * Professioal Forecasters' Probability of Declie i Real GDP, Quarters Ahead US yoy growth rate vs yoy growth rate 8 quarters ago 9 Source: Federal Reserve Board, Goldma Sachs Global Ivestmet Research Source: Federal Reserve Board, Goldma Sachs Global Ivestmet Research At the same time, our ecoomists see potetial for a pickup i US core iflatio ext year as the US uemploymet rate is expected to go sigificatly below. Our ecoomics team estimate this to be the iflectio poit after which wage iflatio teds to accelerate. Combied with deceleratig growth, this could make the ecoomy appear it is eterig a late cycle iflatio overshoot for the first time sice 988 (see Exhibit ad Still Mid-Cycle). Historically, gold has bee the best performig asset i this eviromet as ivestors become cocered with currecy debasemet ad risig macro ucertaity ad iterest rates hurt equities ad bods returs (see Exhibit ). Exhibit : We believe that the US is still mid-cycle but gettig closer to iflatio overshoot late cycle stage Exhibit : Gold teds to outperform equities ad bods durig both the iflatio overshoot late cycle stage ad durig recessios Idex 9 8 Similarity to Average Characteristics of Busiess Cycle Stage Early Cycle Mid Cycle Idex 9 8 Average aualized returs 9-8 Gold price retur S&P retur year treasuries Recessio Early Cycle Mid Cycle Late Cycle - Iflatio Overshoot Late Cycle - Fiacial Overshoot 8 - Late cycle iflatio overshoot Recessio Midcycle Early cycle Late cycle fiacial overshoot Source: Goldma Sachs Global Ivestmet Research Source: Goldma Sachs Global Ivestmet Research, Haver So why the have gold ETF flows bee so weak this year despite the risig late-cycle fears? We thik that the ETF liquidatio was ot the begiig of persistet outflows due to fallig demad for gold as a defesive asset, like it was i, but rather a temporary cleaig up of speculative positios due to stroger dollar cappig gold s short-term upside. The ETF liquidatio occurred i parallel with a fall i et-speculative positios o the Comex, which happeed off of strog dollar mometum vs. major gold cosumer currecies (see Exhibit ). Most of the ETF liquidatio sice August was cocetrated i the SPDR ETF. Quarterly reportig data shows that the st half of liquidatio i SPDR ETF was maily drive by hedge fuds ad baks, while other October 8

6 ivestmet advisors holdigs (which ted to be held by more log-term ivestors) have basically remaied flat (see Exhibit ). Exhibit : Strog dollar capped gold s short-term upside ad led to a correctio i gold et speculative futures positios Exhibit : The ETF liquidatio was also drive by more speculative holdigs Gold et specs (lhs) Gold cosumer currecies dollar chage over moths Other ivestmet advisors Hedge fuds ad baks Source: Thomso Reuters, Goldma Sachs Global Ivestmet Research Aother bullish catalyst ca come from cetral baks. A icreasig umber of coutries are returig back to buyig gold for the first time sice 8-. For some CBs, such as Idia, the shift towards gold is likely drive by the desire to diversify some of their exposure to US treasury holdigs i a risig iterest rate eviromet. For may others, however, political reasos may drive their gold accumulatio. Russia ad Turkey icreased their gold purchases after tesios with the US icreased (see Exhibit ). Polad has also recetly begu buyig gold for the first time sice 998. Most recetly Hugary aouced that it has icreased its gold reserves times to. toes. For both Polad ad Hugary the purchases coicided with risig tesios betwee these coutries ad the Europea Commissio. That said, while the medium-term outlook for cetral bak gold demad is solid, i the short term it could face risks from cotiued dollar stregth. For example, Turkey (or rather Turkish commercial baks which hold their gold i the cetral bak) was forced to liquidate part of its gold holdigs durig its currecy crises early this year (see Exhibit ). Exhibit : Russia ad Turkey CB gold purchases icreased after rise i tesios with the US Exhibit : Gold holdigs i Turkish CB fell after it experieced a currecy crisis Mil toz YOY... Turkey CB gold holdigs Maida i Ukraie Russia CB gold holdigs Adrew Broso arrest i Turkey Mil toz YoY..... Mil toz 9 8 Turkish CB gold holdigs Turkish lira exchage rate (rhs, iv)..... Ja Jul Ja Jul Ja Jul Ja 8 Jul 8 Source: IMF, Goldma Sachs Global Ivestmet Research October 8

7 Fially, as we have demostrated i our framework, EM wealth ca be as importat (ad i the log ru is more importat) a driver of gold prices as chages i safe have demad. EM dollar purchasig power, particularly i the short ru, is heavily impacted by EM currecies which have bee very weak this year. Goig forward our ecoomists expect EM growth ad currecies to stabilize give oly a hadful of coutries, amely Turkey ad Argetia, have structural problems. Our FX strategy team highlights (see EM FX Back to assessig value) that EM currecies ow appear to be udervalued vs. the USD. I additio, i Chia, they argue that premier Li s commets Oe-way devaluatio will do more harm tha good to Chia s ecoomy. Chia will by o meas stimulate exports by devaluig the yua suggest that although policy makers are likely to cotiue a broad-based policy looseig to offset the effects of trade tesios, a sharp weakeig of the CNY is less likely for ow to be part of this mix (see Global FX trader). Therefore i our base case we expect the EM wealth effect to switch from beig a drag o the gold price to a tailwid like it was i. With that said our FX strategy team highlights that risks remai for their dollar outlook, as Turkey could reverse the tighteig course ad if tesios betwee Chia ad the US cotiue to deteriorate, some weakeig i the CNY is possible (see here). While the DXY has stabilized the cosumer weighted dollar idex cotiues to weake (see Exhibit ). At the same time EM CAI cotiues to slow drive by Chia which is the largest gold market i the world (see Exhibit 8). This creates some short-term risks to our forecasts. Exhibit : While dollar stabilised vs. developed market currecies (DXY idex) it keeps o stregtheig vs. the basket of gold cosumers Exhibit 8: EM CAI cotiues to decelerate drive by Chia Idex Oct =.8 Cosumptio weighted gold dollar idex. Idex Oct =.8 DXY dollar idex. 8 EM CAI Chia CAI Oct- Ja-8 Apr-8 Jul-8 Oct Source: Goldma Sachs Global Ivestmet Research The CNY exchage rate is of particular sigificace to gold give that sice the ed of the gold price has bee much more stable i CNY terms vs the dollar (see Exhibit 9). Ideed we fid that post-november Swiss gold exports to Chia have become much more sesitive to both the dollar gold price ad the CNY exchage rate (see Exhibit ). The chage i gold purchasig patter coicided with the electio of Presidet Trump, who promised to get tough o Chia durig his electio campaig. Give that our ecoomists do t expect the US Chia trade tesios to go away aytime soo we would expect the CNY sesitivity of Chiese gold purchases to remai elevated. October 8

8 Exhibit 9: Sice US presidetial electio i gold has bee much more stable i CNY terms vs. dollars Exhibit : Post November Swiss gold exports to Chia have become much more sesitive to chages i both CNY ad the gold price Ratio Volatility of gold i CNY vs volatility i USD US presidetial electio 8 9 Ratio Swiss et gold exports to Chia ad Hog Kog Explaatory variable Coefficiet T-stat Sample: Ja - Nov Costat..9 Gold price chage over the past two moths CNY chage over the past two moths Lagged gold exports to Chia. 9. Sample: Dec - Aug 8 Costat. Gold price chage over the past two moths - -. CNY chage over the past two moths Lagged gold exports to Chia Source: Swiss Customs, Goldma Sachs Global Ivestmet Research To sum it up, our framework suggests solid fudametals for gold. A low ad fallig US uemploymet rate combied with slowig growth ad risig iflatio should boost fear related DM gold demad. A reboud i EM dollar GDP icreases their gold demad through the wealth chael. O top of this, risig geopolitical tesios create upside risk to cetral bak gold demad. However, we also highlight some short-term headwids related to volatility i EM currecies ad the CNY i particular. We keep our, ad m forecasts at $/toz, $/toz ad $ but see upside risks oce US growth begis to slow. October 8 8

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