Etikett: DXY

Gold Reacts to Fed Hawks in June

VanEck Joe Foster Gold Reacts to Fed Hawks in JuneGold Reacts to Fed Hawks in June

VanEck Joe Foster Gold Reacts to Fed Hawks in June

Gold continued its range-bound trading pattern, fluctuating between $1,200 and $1,300 per ounce since January. In June the price fell $27.39 (-2.16%) to end the month at $1,241.55. On June 14, the Fed raised rates for the fourth time in this rate hiking cycle. A common pattern emerged for the first three rate hikes with gold price weakness ahead of the hikes, followed by a rally to higher prices immediately after each hike. This pattern then changed, as gold reached its high for the year ($1,298 per ounce) on June 7 before the hike and subsequently trended lower for the rest of the month. Gold came under pressure as hawkish statements by the Fed following the Federal Open Market Committee (FOMC) meeting raised the odds of a fifth rate increase later in 2017.

The U.S. dollar gained strength temporarily following the FOMC meeting, but ended June with a 1.4% loss, as measured by the U.S. Dollar Index (DXY),1 which fell to nine month lows. The weakness was caused by comments from top officials from the European Central Bank (ECB) and Bank of England (BOE), which the markets interpreted as suggesting that some removal of monetary accommodation could be warranted soon. Also weighing on the U.S. dollar was the International Monetary Fund (IMF) downgrade of its 2018 U.S. GDP growth forecast to 2.1% from 2.5%. The global economy appears to be set to outpace the U.S. economy over the coming year.

Gold Hurt by Intense Selling Pressure, and Possible Manipulation

The June performance of gold was disappointing given the weakness in the U.S. dollar. Gold normally has an inverse correlation2 with the dollar. However gold came under intense selling pressure that looks suspiciously like someone was set on manipulating the market lower. On June 26 before European markets opened at 4:00 a.m. U.S. Eastern Time, the futures market was hit with a 1.8 million ounce sell order that drove the price down $18 in an instant. The selling came during off hours when liquidity was light and it pushed the price below the technically important $1,250 per ounce level.

Further selling pressure on the day before the Fourth of July holiday in the U.S. had gold looking to test the $1,200 level. We have not seen this type of (presumably) manipulated selling pressure since the bear market period from 2013 to 2015. We assume this activity originates with banks or hedge funds attempting to generate a profit, or with a government attempting to dampen competition with the U.S. dollar. We will never know the source, or whether it is part of a broader conspiracy, so we do not waste further time considering the possibilities. In the longer term, the market is too broad and deep to be manipulated successfully.

Mixed Results for Gold Equities

Gold stocks were mixed in June. The NYSE Arca Gold Miners Index (GDMNTR)3 followed gold lower with a loss of 2.87%, whereas the MVIS™ Global Junior Gold Miners Index (MVGDXJTR)4 posted a gain of 5.59%. The junior miners are showing some mean reversion after being oversold ahead of a major Index rebalance that occurred on June 16.

Waiting for a Strong Catalyst to Propel Gold off its Base

Since the bear market ended in December 2015, the price of gold and gold shares has been forming a base. We have yet to see a strong catalyst, however. Thus far in 2017, U.S. dollar weakness and a general nervousness on many geopolitical fronts have provided solid support for gold as a currency alternative and hedge against risks. Gold ended the first half with a modest gain of 7.75%. Gold stock indices underperformed gold as GDMNTR gained 5.29% and MVGDXJTR rose 3.47%. We normally expect gold stocks to outperform gold in a rising market. The underperformance of the indices this year is likely due to:

1. Mean reversion after stellar outperformance in 2016;
2. Heavy net redemptions in the gold mining ETFs;
3. Inability of stock indices to engage in fundamental stock selection.

Support Exists for Current Price Levels

The market is now in the midst of the summer doldrums, a time when physical demand is at its lowest, trading volumes can be light, and, as we saw in late June and early July, the bears come out to play. The gold price is testing the $1,200 per ounce level for the third time this year. If $1,200 fails, then it will go on to test the $1,175 base of the uptrend that has developed over the past 18 months. Successfully holding above these price levels would be very positive technically and psychologically for the market. Fundamentally, we believe the market is well supported around current levels because:

1. Physical demand in India and China continues to improve, even though the People’s Bank of China (PBOC) has yet to buy gold in 2017. We believe the PBOC is on pause this year due to foreign exchange and debt issues in China;
2. Geopolitics in the Middle East and Korea—along with uncertainty surrounding the U.S. political climate and policy—has created a pervasive nervousness globally that benefits gold;
3. The U.S. dollar appears to be in decline. While it did not help gold in June, we expect the historically negative correlation to benefit gold in the longer term;
4. Positioning in the futures market suggests there could be more buying ahead.

To Gold’s Benefit, This Fed Rate Hiking Cycle is Likely to End in Tears

We continue to be positive on the gold price in the longer term. Based on what we see and hear every day, all of us can imagine possible black swan5 events that might propel gold much higher. When we look at the economic cycle in the U.S., we find a more compelling investment case. Our March commentary highlighted many signs of a late cycle economy. In our May commentary, we published an ominous looking chart of NYSE margin debt. Complacency is at high levels typically seen at market tops. Investors continue to pour money into ETFs, driving stock market indices to new highs, while volatility as measured by the VIX Index6 is at historic lows. Most Fed rate hiking cycles end in tears. Will this one be any different?

Gold Remains a Solid Money Alternative Given Financial Risks

Gold would likely benefit from dollar weakness if the Fed is unable to raise rates later this year. In the longer term, when the economy and markets eventually see a downturn, the risks to the financial system will probably be substantial. Historically, excessive leverage is the core cause of financial upheaval. Student loans, automotive loans, and credit card debt are each over $1 trillion now. The ”elephant in the debt room” remains sovereign debt levels that exploded higher after the last financial crisis and has been growing ever since. A shrinking economy magnifies debt problems and, with interest rates still far below normal, would likely see the Fed again resort to quantitative easing and maybe more extreme intervention, such as debt monetization. Gold as a sound money alternative can act as a hedge against such risks.

by Joe Foster, Portfolio Manager and Strategist

With more than 30 years of gold industry experience, Foster began his gold career as a boots on the ground geologist, evaluating mining exploration and development projects. Foster is Portfolio Manager and Strategist for the Gold and Precious Metals strategy.

Please note that the information herein represents the opinion of the author and these opinions may change at any time and from time to time.

Important Information

1 U.S. Dollar Index (DXY) indicates the general international value of the U.S. dollar. The DXY does this by averaging the exchange rates between the U.S. dollar and six major world currencies: Euro, Japanese yen, Pound sterling, Canadian dollar, Swedish kroner, and Swiss franc.

2 The correlation coefficient is a measure that determines the degree to which two variables’ movements are associated and will vary from -1.0 to 1.0. -1.0 indicates perfect negative correlation, and 1.0 indicates perfect positive correlation.

3 NYSE Arca Gold Miners Index (GDMNTR) is a modified market capitalization-weighted index comprised of publicly traded companies involved primarily in the mining for gold.

4 MVIS Global Junior Gold Miners Index (MVGDXJTR) is a rules-based, modified market capitalization-weighted, float-adjusted index comprised of a global universe of publicly traded small- and medium-capitalization companies that generate at least 50% of their revenues from gold and/or silver mining, hold real property that has the potential to produce at least 50% of the company’s revenue from gold or silver mining when developed, or primarily invest in gold or silver.

5 Black swan is an event or occurrence that deviates beyond what is normally expected of a situation and is extremely difficult to predict.

6 VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market’s expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options.

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Profit-taking in oil as price slides after OPEC meeting

Profit-taking in oil as price slides after OPEC meeting

ETF Securities Weekly Flows Analysis – Profit-taking in oil as price slides after OPEC meeting

  • Crude oil ETPs experience largest outflows in six months after OPEC agrees output cut extension
  • Industrial metal ETPs inflows hit seven-year high as speculative unwind eases
  • Investors enamoured with tech ETPs sees 11th consecutive week of inflows, totalling US$34mn
  • US Dollar buying continues at the expense of the Euro, with sixth consecutive week of inflows

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Crude oil ETPs experience largest outflows in six months after OPEC agrees output cut extension. OPEC and its non-OPEC partners have agreed to freeze production at current levels for another nine months The Saudi-Arabian led cartel has sought to bolster prices after the price collapse that emerged when its 2014 experiment failed and crippled many OPEC member economies. A deeper cut would be need to shock the market to drive prices higher. With US, Canadian and Brazilian production continuing to grow and global demand remaining soft, global oil inventories will remain elevated. OPEC’s target of bringing down the level of OECD oil inventories to its 5-year average will continuingly be undermined by the growth in US shale oil. As a result, crude prices slid and investors took the opportunity to book profits, with long oil ETPs experiencing the largest withdrawal since early December 2016, totalling US$100mn.

Investors enamoured with technology ETPs sees 11th consecutive week of inflows. The tech sector continues to lead equity global performance, as tech earnings in the US have come in better than expected. The inflows into both cybersecurity and robotics themed ETPs totalled US$34mn, the largest inflows in 11 weeks.

US Dollar buying continues at the expense of the Euro, with 6th consecutive week of inflows. Although the market is fully pricing in a rate hike in the US at the Federal Reserve’s June meeting, the US Dollar continues to weaken. Last week, the US Dollar index (DXY) reached the lowest level since October 2016. Futures positioning has moderated in recent weeks, in line with the price weakness. In contrast, ETP investors have been optimistic, driving inflows into long USD ETPs for the 6th consecutive week. Inflows over that period have totalled US$57mn. At the same time, investors have been cutting positions from short USD ETPs, with withdrawals totalling US$15.3mn. Last week’s outflows were the largest from short USD ETPs since the first week in January 2017. The primary buying of USD came against the Euro which broke above key resistance at 1.12 level. Long Euro ETPS experienced the largest withdrawals in 20 weeks, while short Euro ETPs tallied the sixth consecutive week of inflows.

Industrial metals inflows reach seven year high. Investors have taken the stabilisation in metals prices as a signal to start bargain hunting in the sector. Speculative unwind has begun to ease and with signs of stabilisation in the Chinese economy and China’s authorities initiating new infrastructure programs. Broad industrial metals basket received US$42mn, the largest in seven years.

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Trade Idea Dollar downside

Trade Idea Dollar downside

Trade Idea – Foreign Exchange – Dollar downside

Talked lower

Next Friday, 2017’s first US nonfarm payroll report will be released and could determine the near term fate of the US Dollar. The widely monitored DXY dollar basket has moved 2.9% lower over the month, retracing a portion of the sharp 7.1% rally experienced in the fourth quarter of last year. A strong payroll figure could re-ignite rate hike expectations and put the US Federal Reserve’s (Fed) March meeting back into play (rate hike currently priced at around 20%*), while a weak slate could confirm predictions that the Fed will adopt a more dovish stance than is currently being suggested. We believe it is likely that the US Dollar has further room to run lower in the coming months as the Fed remains on the side-lines (i.e. does not hike rates in March) and extended speculative positioning unwinds. This is most likely to be witnessed against the GBP and EUR, as the JPY has already experienced a considerable correction and oil-related currencies remain subject to supply concerns. Rhetoric from Trump’s administration, specifically him and his Treasury secretary nominee, Steven Mnuchin, also has potential to weigh on the US Dollar from a sentiment perspective. Both figures have emphasised the detrimental effect of an “excessively strong US Dollar” on the wider American economy and further comments could add to bearish momentum currently surrounding the currency.

Overstretched and overdone

Speculative futures positioning data suggests that net long US Dollar positions have moderated somewhat in recent weeks. However, gross long US Dollar positions remain considerably elevated and short positing near record lows (see Figure 1), so further correction potential remains. Technically speaking, while momentum indicators turned lower for the US Dollar at the start of the year, they remain on an established downward trend and some way from bottoming. The EUR/USD is trading near its 38.2% Fibonacci retracement at 1.07, and any break could see it head towards its 100 daily moving average (DMA) of 1.082. Meanwhile, the GBP/USD recently broke through its 50 DMA and has potential to head towards its own 38.2% Fibonacci retracement at 1.28. Investors wishing to express the investment views outlined above may consider using the following ETF Securities ETPs:

Currency ETPs

GBP Base ETFS Long EUR Short GBP (GBUR) ETFS Short EUR Long GBP (URGB) ETFS Long USD Short GBP (GBUS) ETFS Short USD Long GBP (USGB) USD Base ETFS Long GBP Short USD (LGBP) ETFS Short GBP Long USD (SGBP) ETFS Long EUR Short USD (LEUR) ETFS Short EUR Long USD (SEUR) EUR Base ETFS Long USD Short EUR (XBJP) ETFS Short USD Long EUR (XBJQ) ETFS Long GBP Short EUR (EUGB) ETFS Short GBP Long EUR (GBEU) 3x ETFS 3x Long USD Short EUR (EUS3) ETFS 3x Short USD Long EUR (USE3) ETFS 3x Long GBP Short EUR (EGB3) ETFS 3x Short GBP Long EUR (GBE3) ETFS 3x Long GBP Short USD (LGB3) ETFS 3x Short GBP Long USD (SGB3) ETFS 3x Long EUR Short USD (LEU3) ETFS 3x Short EUR Long USD (SEU3) ETFS 3x Long USD Short GBP (USP3) ETFS 3x Short USD Long GBP (PUS3) ETFS 3x Long EUR Short GBP (EUP3) ETFS 3x Short EUR Long GBP (SUP3) 5x ETFS 5x Long GBP Short EUR (EGB5) ETFS 5x Short GBP Long EUR (GBE5) ETFS 5x Long USD Short EUR (5CH5) ETFS 5x Short USD Long EUR (5CH6) ETFS 5x Long USD Short GBP (USP5) ETFS 5x Short USD Long GBP (PUS5) Basket ETFS Bullish GBP vs G10 Currency Basket Securities (LGBB) ETFS Bearish GBP vs G10 Currency Basket Securities (SGBB) ETFS Bullish USD vs G10 Currency Basket Securities (LUSB) ETFS Bearish USD vs G10 Currency Basket Securities (SUSB) ETFS Bullish EUR vs G10 Currency Basket Securities (LEUB) ETFS Bearish EUR vs G10 Currency Basket Securities (SEUB) The complete ETF Securities product list can be found here.

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Gold’s fair value at US$1440 as uncertainty reigns

Gold’s fair value at US$1440 as uncertainty reigns

Gold’s fair value at US$1440 as uncertainty reigns. The US Dollar, Yen, the Swiss Franc and gold have all been beneficiaries of investors seeking haven asset as Britain’s decision to leave the EU has left the world in shock. We believe prolonged uncertainty will keep demand for defensive assets elevated. Gold’s fair value at US$1440 as uncertainty reigns Net speculative futures market positioning in gold had already risen to all-time high before the “Brexit” vote and we suspect positioning has moved considerably higher in recent days (data only available weekly with delay). Net speculative positioning hit a record high of 316,525 long contracts last Tuesday, far above the 289,250 net longs hit during the worst of Greek sovereign crisis and considerably above the 83,000 contract average since beginning of the series. Given the lack of clarity about the future course of the UK’s relationship with the EU or other countries, we expect market uncertainty to keep demand for gold strong for some time and that will be reflected in elevated speculative positioning. Analysts will struggle to assess the impact of Brexit until Article 50 of the Lisbon Treaty is invoked and it could take up to two years after that point for the UK to formally leave. The US Dollar basket (DXY) has risen by close to 4% since the announcement of Brexit. We believe that it could rise further as investors look for haven assets. We also assume the US Federal Reserve will at some point in the coming year raise interest rates (on the assumption that Brexit contagion to the real economy of the US is limited). While US Dollar appreciation is usually gold price-negative, the rise in haven demand is often more price-positive. Indeed we have seen over the past few days that gold and the US Dollar have both risen.
Given the heightened uncertainty about how events will unfold, we present some scenarios for gold prices. We use our proprietary gold model that we presented in “Policy mistakes provide upside potential for gold” and vary the assumptions on US Dollar movements and level of speculative positioning (presented above). We assume that US inflation will hover around 1.1% (around current levels), based on 1yr-1yr break-evens and nominal 10 year Treasury rates will also remain around current levels even if policy rates rise (we assume a bond curve flattening rather than a shift). Using our central assumptions, for example a modest US Dollar appreciation of 5% and speculative positioning remaining elevated, but moderating to 200,000 contracts, gold is likely to trade around US$1440/oz by June 2017. In the absence of any US Dollar appreciation, gold could trade closer to US$1500/oz.

Nitesh Shah, Research Analyst at ETF Securities

Nitesh is a Commodities Strategist at ETF Securities. Nitesh has 13 years of experience as an economist and strategist, covering a wide range of markets and asset classes. Prior to joining ETF Securities, Nitesh was an economist covering the European structured finance markets at Moody’s Investors Service and was a member of Moody’s global macroeconomics team. Before that he was an economist at the Pension Protection Fund and an equity strategist at Decision Economics. He started his career at HSBC Investment Bank. Nitesh holds a Bachelor of Science in Economics from the London School of Economics and a Master of Arts in International Economics and Finance from Brandeis University (USA).

Time to increase allocation into emerging market equities

Time to increase allocation into emerging market equities

ETF Securities Asset Allocation Research – Time to increase allocation into emerging market equities

Summary

• Until recently developed market (DM) equities have been favoured over emerging market (EM) equities due to concerns over the slowdown of the Chinese economy.
• However, EM economies are recovering, investment flows are returning to emerging countries and EM equities are currently very cheap on absolute and relative values.
• Using the US dollar as a trading signal is a simple way to allocate between DM and EM equities and enhances the portfolio risk/return profile by increasing return.

Emerging market economy to rebound

The slowdown in EM equities has been driven by a combination of factors including the economic slowdown of its main constituent China, as the country is making its transition from an industry-driven economy into a service-driven economy and the slump in oil prices which affected many emerging countries such as Saudi Arabia.

Manufacturing PMIs for both DM and EM countries have been declining since early 2014. While DM PMIs remained above the 50 mark, EM PMIs fell below the 50 mark in August 2015 according to our calculations, before recovering last month.

(click to enlarge) Source: ETF Securities, Bloomberg

According to the Institute of International Finance (IIF), the year-over-year growth in foreign investment inflows into emerging countries has also been declining since May 2013 to become outflows in January and February 2016. According to market participants, EM companies have been through a period of deleveraging, repaying their foreign debt and refinancing them into local currencies. If this is the case, EM companies are getting healthier, setting the base for a potentially strong recovery. Total investment flows recovered for the first time last month, up US$3.4bn year-over-year, after 13 months of continuous decline.

(click to enlarge) Source: Institute of International Finance, ETF Securities, Bloomberg

Emerging market equities at a bargain

Our valuation analysis of DM and EM equities shows that EM equities are currently very cheap compared to DM equities as the relative, cyclically adjusted price to earnings (CAPE) currently stands at 35% below its 11 years median of 0.72.

(click to enlarge) *MSCI World index as proxy for DM equities and MSCI EM index as proxy for EM equities. Source: ETF Securities, Bloomberg

EM/DM relative CAPE has been declining since mid-2013 as EM CAPE has been falling 33% while DM CAPE has been quite flat over the same period. EM CAPE is 44% below its 11 years median, indicating that EM equities are also cheap in absolute value.

We use the MSCI world index as a proxy for DM equities and the MSCI EM index as a proxy for EM equities. While EM equities are more volatile than DM equities, EM equities have outperformed DM equities by an annualised 53% since 1988. The largest component for the EM index is China and the largest component for the DM index is the US, both accounting for 39% of their respective index.

Using USD to increase equity returns

As the benchmark currency for international trades, the US dollar (USD) is one of the key drivers of equity performance. Following the financial crisis, very accommodative monetary policy from the Fed weighed on the USD until the second half of 2014. Between the summer 2014 and the end of 2015, the USD surged 25% as the Fed reduced quantitative easing. EM equities, on the other hand, fell 23% over the same period.

In 2015, strong signs of US economic recovery led the Fed to initiate a rate tightening cycle, with the first rate hike in December last year. After a pause in the tightening cycle, we believe that the USD will appreciate as markets anticipate forthcoming rate increases but then it will depreciate again as rate hikes materialise. EM equities tend to perform well during periods of weak USD and vice-versa.

One simple and rational way to implement a relative trade strategy between EM and DM equities is to use the USD as a trading signal. In our strategy, we are using the dollar basket index (DXY) as a proxy for the USD. It measures the value of the USD against a basket of DM currencies. While the Fed’s trade-weighted USD index benchmarks the USD against a broader basket of currencies including EM currencies, we decided to use the DXY because of its stronger correlation with DM/EM relative performance.

(click to enlarge) *DXY Index as a proxy for the US dollar. Source: ETF Securities, Bloomberg

Our strategy is a momentum strategy which consists of buying DM equities when the USD has strengthened by more than 1.5% over the past 6 months and then shifting to EM equities when the USD has weakened by more than -1.5% over the past 6 months. As a result, the investment decision is not dependent on forecast data but only based on actual USD or DXY index historical returns over the past 6 months.

(click to enlarge) Source: ETF Securities, Bloomberg

Exposed to equity only, our portfolio does very little to reduce volatility, at 16.6% compared to 14.7% for the MSCI AC World, our benchmark. However, the strategy still enhances the portfolio Sharpe ratio to 0.40 from 0.08 by increasing returns by 122% compared to the MSCI AC World index.

The portfolio also outperformed both DM and EM equities on an annual basis over the same period by 119% and 43% respectively while being less volatile than EM equities. In addition, the transaction cost is expected to be very low as the number of transactions in the simulated portfolio stands at around two transactions per year on average.

(click to enlarge) *Based on daily data in USD from December 30, 1988 to March 31, 2016. Volatility and returns are annualised. Max drawdown defines as the maximum loss from a peak to a trough based on a portfolio past performance. Max recovery is the length of time in number of years to recover from the trough to previous peak. Risk free rate equals to 3.2% (Cash – a simulated combination of the IMF UK Deposit Rate and the Libor 1Yr cash yield). Source: ETF Securities, Bloomberg

After three years of negative performance, emerging markets are starting 2016 on a positive note, posting a solid 5.4% return during the first quarter of 2016 while DM equities were down – 1%. EM manufacturing PMIs for March have returned above the 50 mark indicating that emerging economies are recovering. Capital flows into EM are increasing again and our valuation analysis shows that EM equities are currently at a bargain, indicating that it is an opportune time to gain exposure or increase exposure to EM equities. With EM growth highly correlated to the USD, using the currency as a trading signal enables investors to increase their portfolio return and improve its Sharpe ratio by shifting exposure between DM and EM equities at a low implementation cost.

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