Financial markets love nice, round numbers. Maybe the most famous nice, round number of all is a price of 2,000 US dollars for a troy ounce of gold. In early August, COMEX Gold futures (ticker symbol GC) crossed that threshold for the first time ever with the GC contract for August delivery settling at $2,001. The December 2020 delivery contract went even further, reaching a price of $2,069 on August 6. After having reached that level, the market came back down somewhat but it remains above $1,900. Understandably, the recent price action captured many traders’ attention. One item at a time, we look at recent developments in the gold market.
Gold strength means dollar weakness and vice-versa. Because of the unprecedented fiscal and monetary responses to the COVID-19 crisis, the US dollar has recently fallen out of favor. The worry is that an accommodating Federal Reserve will let inflation run loose, thereby weakening the status of the US dollar as the global reserve currency. Gold is strengthening versus the dollar, but so is the Euro, the Yen, and the Swiss Franc, which have all increased versus the greenback year to date. Even without gold-specific factors coming into play, the precious metal would be expected to gain value when the dollar’s main challengers are strengthening.
The same factors also show themselves in a low-yield environment for dollar-denominated assets. Bond buying by the Federal Reserve and others has effectively put a cap on nominal yields. With higher inflation expectations, this translates into record-low real yields. The negative correlation between inflation-adjusted yields and gold prices has been well documented in the past and continues to hold true.
Net positioning by managed money – the category that includes hedge funds, commodity trading advisors, etc. – shows a bullish bias. Net long positions are currently at around 100,000 contracts. This is on the high side by historical standards, but certainly not at extreme levels. In fact, net long positions are below where they were at the beginning of the year, when gold was trading at $1,600. At the same time, open interest in COMEX GC futures is now on the rise. It started the year at record high levels of 800,000 open contracts and decreased to below 500,000 at its trough in early June. As of late August, it is now back to about 550,000 contracts – below the record high, but a number that is in line with the past few years.
Gold is a widely accepted yardstick, and it is useful to measure its price as a ratio to other commodity assets. For instance, the gold-to-copper ratio can indicate the relative health of the world economy. Unlike gold, copper is widely used in industry and generally serves as a bellwether for economic activity. The gold-to-copper ratio has been steadily increasing since early 2018, a long time before the start of the COVID-19 pandemic. Its rise overlaps with the onset of the US-China trade conflict. The gold-to-copper ratio has now slightly decreased from record-high levels, but it remains elevated. A high ratio signals that the world economy remains in dangerous territory. In this environment, it is no surprise that gold continues to be sought after for its safe-haven appeal.
To a lesser extent, the gold-to-silver ratio plays a similar role. Silver has industrial applications, notably in photovoltaics. This ratio reached an all-time high level of above 120x back in March – this increase was mostly due to silver selling off aggressively when COVID-19 forced global lockdowns. However, starting in the second quarter, silver continuously outperformed gold and thereby pushed the ratio back to levels of around 70, below where it started the year. Unlike gold, silver is still a long way off its record highs.
There are many reasons why gold has found strong buying interest in 2020. The global economic outlook is highly uncertain. Governments and central banks have to deal with an unprecedented crisis and have resorted to drastic measures in response. In these times, gold is shining brightly as the investment community continues to value its safe-haven appeal. Open interest and net positioning by market participants shows healthy participation in GC futures trading. With high liquidity through the trading day, GC futures remain the prime contract for global gold trading.
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