Gold Is Back Big Time: Draghi And Bernanke Prime The Pump
The return of central banks to the driver’s seat has brought with it an impressive gold rally. While the yellow metal had mounted a stealth rally in the run up to Bernanke’sJackson Hole speech, it went into in anticipation to Draghi’s bond purchase announcement as investors re calibrated their portfolios to price-in aggressive monetary easing. In a world where bad news is good news given the rising chances of quantitative easing, investors piled into gold after Friday’s disappointing jobs report.
Gold closed the session at $1,739.90 an ounce in New York on Friday, up $32 or 1.9%. Only a week ago it traded at $1,660.10.
The wild surge in the precious metal’s price is directly tied to the workings of global central banks, particularly in Europe and the U.S. It’s been a choppy year for gold, and for risk assets in general, with a first quarter rally and marked second quarter slump. After a summer hiatus, the yellow metal is trending up again, with the GLD ETF up more than 9% over the past three months as it became increasingly clear that the Fed is rolling up its sleeves and getting to work.
The culmination of that stealth rally was Bernanke’s Jackson Hole speech, where he outlined the case for further easing and defended QE. With investors now taking their cue from central bankers, gold started making headlines once again.
Since then, ECB chief Mario Draghi has taken the lead. Gold futures spiked on Friday August 31, ahead of Labor Day. That Monday (September 3), European markets were open and news agencies leaked the framework of Draghi’s “Outright Monetary Transactions” (OMT). In terms of gold markets, the OMT will have a muted effect, explained UBS’ Edel Tully, given the bond purchases (designed to lower borrowing rates for troubled sovereigns like Spain and Italy) are going to be sterilized. No balance sheet expansion means less support for gold, which benefits from excess liquidity.
While gold investors weren’t entirely happy, the yellow metal is currently strongly correlated with the euro, and Draghi’s bond purchases should be supportive of the single currency. Indeed the euro has rallied strongly against the U.S. dollar, jumping 1.33% on Friday to 1.28; the single currency traded nearly at 1.20 against the greenback in July.
The yellow metals’ 20-day rolling correlation with the euro-dollar exchange rate stands at 0.69, according to Tully (which means 69% of its price movement is explained by movements in the currency pair), not far off its 2012 high of 0.8.
The second main factor behind gold’s precipitous rise is the value of the U.S. dollar, which has been falling since mid-July. Bernanke’s Jackson Hole speech and Friday’s disappointing jobs report have both fueled further deterioration in the value of the greenback, given speculation that the Fed will unleash more quantitative easing. Indeed, gold had lost some of its luster after Thursday’s solid ADP report, which many took to mean stronger nonfarm payrolls a day later. The crummy report from the BLS on Fridaysparked another day of solid gains for risk assets like gold.
Investors are now eagerly awaiting the Fed’s September 12 and 13 FOMC meeting. Speculation as to what Bernanke & Co. will do has ranged from an extension of forward guidance to full blown QE3; Nomura’s economics team suggests the former. At the same time, a German Constitutional Court will be ruling on the legality of the ESM emergency mechanism in Europe, while the Eurogroup summit of Finance Minister is scheduled for the 14 in Cyprus. All of these will be key events for investors, particularly in gold markets. Easing should buoy the yellow metal, while decisive action across the Atlantic could lead to further strengthening of the euro; both are gold supportive. The recent rally does call for caution, though, as it has been precipitous.
Accompanying the recent rally have been the miners. Stock in the gold sector including GoldCorp, Newmont Mining, and Barrick Gold have all mounted rallies north of 9% over the last month. Incredibly absent has been AngloGold Ashanti, which counts with billionaire John Paulson as a major shareholder, in part because of its operations in South Africa, where labor disputes have pitted miners against riot police.
Gold is back, but not because of its traditional safe-haven qualities. Rather, it is a proxy for central bank action and the debasement of the world’s reserve currency, the U.S dollar. A violent asset class, investors should be careful when jumping in after such strong rallies, but the possibility of more Fed easing may be difficult to resist.