In line with my expectations outlined in my Q3 outlook, gold prices have continued to weaken, reflecting a lack of safe-haven demand among investors combined with growing market expectations that the Fed will start to normalise its monetary policy at the September FOMC meeting.
The lack of safe-haven demand during the Greek crisis earlier in July, as reflected by strong outflows in gold ETFs (as seen in the figure below), suggests that investors have viewed gold as an underperforming safe-haven asset and have instead preferred to buy US government bonds in a bid to express their macro concerns.
Meanwhile, market participants have steadily marked up their expectations regarding the start of monetary policy firming and the path of the federal funds rates. The release of the July FOMC meeting is another confirmation that the FOMC remains confident that the US economy will continue to improve, which will warrant, at some point this year, an initial increase in the federal funds rate. Against this backdrop, market participants likely increased their long exposure to the US dollar, which apparently placed downward pressure on gold prices.
The weakness in the gold market intensified in July, pushing prices to a new 2015 low of $1,078 per ounce on July 24 (intraday basis). Since then, gold prices have traded sideways to lower, which could suggest that a bottoming-out process is about to emerge. Indeed, I see two arguments that could support such a thesis. First, as highlighted in the figure above, from a technical perspective, the market appears deeply oversold in the short term, as reflected by the RSI (21), down from 50 in June to 25 in late July. This suggests that upside price reaction is necessary in order to unwind deep oversold conditions. Second, as seen in the figure below, the speculative positioning has deteriorated remarkably since the middle of June, pushing the net spec length from 39,916 long contracts as of June 23 to 14,633 short contracts as of July 28. This extreme bearishness among the speculative community suggests that a rally in gold prices is possible in the near term, essentially driven by short covering.
However, I believe that market participants should be patient before taking on additional positions.
First, the strong sell-off in gold prices is mirrored across all the commodity markets, especially the energy complex, with crude oil prices falling by about 20 percent in July to $47.17 per barrel (see Figure below). As such, it would be wise to wait for selling pressure to come to an end before initiating long positions in gold.
Second, speculators tend to reach an extreme positioning when prices are near a peak or a trough. Consequently, although it would be tempting to build long positions at these current low prices, I suspect that the spec positioning could deteriorate further before it starts improving.
Third, since mid-July, US real interest rates have moved lower while the US dollar has consolidated, which should, in theory, provide a favourable environment for commodities, especially gold. Despite this, gold prices have continued to weaken, suggesting that the market is not ready for a short-covering rally yet. In my view, global macro investors are patiently awaiting the release of the July employment report (released on August 7) before adjusting their portfolios accordingly. Indeed, I believe that this report will be decisive for the Fed's decision-making process regarding the normalisation of its monetary policy. Should the report be stronger than anticipated, gold prices could experience another leg down before bottoming out.
To sum up, while I recognise that the deep oversold conditions in the market combined with the extreme bearishness in the spec positioning could prompt some investors to start building long positions, I hold the view that it may be too early; indeed, I believe that broad-based declines across the commodity markets as well as the lack of upside price reaction despite a weaker US dollar and lower US real interest rates suggest gold prices could decline further to eventually reach the $1,000 critical level before a shift in sentiment occurs. More importantly, while I am relatively comfortable with holding a short position, I stay alert and watch for clear signals that a tangible bottoming-out process is emerging before reversing my positions by 180 degrees.
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