MARKETS always look their very best at the top – that’s increasingly the case with gold as it nears US$3,000 a troy ounce.
It’s behaving like a Veblen good, an item for which, contrary to the laws of economics, demand increases with price. Can the momentum be sustained?
The precious metal has soared 45% in the past year. One key sign of froth is plausible-sounding pet theories for extra cavalry coming over the hill. A couple of beauties are doing the rounds presently.
First, there’s speculation that the Trump administration will revalue its gold deposits, now booked at US$42 per ounce, up to the current spot price.
This magically would add around US$800bil to the asset side of the US balance sheet.
The net effect is that less debt would need to be sold, which is a positive for Treasury bonds and the US dollar, but the logic for this being a boost for gold escapes me.
Secondly, 10 Chinese insurers were permitted this month to put 1% of their balance sheets into physical gold – potentially as much as the equivalent of US$27bil.
This rule change had been widely expected in gold circles for several months – even I knew of it.
But gaining the ability to purchase is a big step away from wading in all guns blazing at the all-time high.
The Chinese central bank is widely cited as the biggest buyer of recent years. After several months’ pause, it added 15 tonnes in the last two months of last year.
However, the premium for Shanghai-traded gold normally rises on yuan weakness, but not this year.
It suggests that Chinese demand isn’t the current driver for new highs. So what is?
Vanda Research, an investment consultancy, points to US institutional buyers diversifying portfolios to hedge against fallout from Trump tariff risks.
It also notes that most of this year’s price gains are being made in US trading hours, not during the Asian day.
Momentum funds have been chasing repeated new highs. However, these types of inflows tend to reverse very quickly if the upside pace isn’t sustained.
Complications with the delivery of gold into New York Comex futures contracts have exacerbated a short squeeze.
Everyone knows gold offers no return and is expensive to store but flying it from depositories in London, Toronto or Zurich to New York adds a whole new cost level.
Arbitrages this wide rarely last long. Nonetheless, US-listed exchange traded funds are finally seeing a pickup in inflows, after barely registering a flicker of interest in gold’s rally this past year.
The usual golden rules are in abeyance, bar one – that the pet rock is the classic inflation hedge.
For now the focus is very much on the inflationary effects of tariffs – even this is so far more a political battle of wills than an economic reality.
Yet, the core price consumption expenditure index, which the US Federal Reserve (Fed) monitors closest, has remained under 3% for the past year.
Similarly, five-year forward inflation swaps are tracking close to 2.5%.
Yes, these are all above the Fed’s 2% target, but chair Jerome Powell is relaxed, with a bias still to ease interest rates. Deutsche Bank AG analysts reckon all the likely US-imposed tariffs and reciprocal reactions would add at most 0.4% to the US consumer price index.
It explains some gold strength but not a 45% surge over the past year.
Trump is all about maintaining the global reserve status of the US dollar, not promoting a rival.
Gold typically has an inverse relationship to the US dollar, and high US Treasury yields are usually kryptonite for gold.
Any curtailment in US borrowing should reduce the fear factors that gold evidently is thriving on.
Furthermore, there aren’t any imminent economic or monetary policy shocks looming that I can espy. If anything, the geopolitical environment is calming down. For sure, equities are showing precious little concern about tariff risks – the German DAX index is even leading the charge this year despite being potentially a hotspot for Trump’s ire.
Gavekal Research points out that all of the bull rationales for gold are very clear, or known knowns, but the bearish catalysts aren’t.
Peace deals in Ukraine and the Middle East would cut gold’s momentum off at the knees.
It’s also worth noting that the usual fellow riders with the yellow metal, such as physical gold miners and other precious metals like silver, aren’t in this posse.
Gold may be hot right now, just as bitcoin is taking a breather, but failure to reach or stay above the US$3,000 level for long might blow off some froth. — Bloomberg
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. The views expressed here are the writer’s own.
