Gold Weekly: Ready To Bounce Again As The Fed Begins Its Easing Cycle

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About: World Gold Shares SPDR Gold Minishares Trust ETF (GLDM)
by: Orchid Research
Summary

Gold is off to a weak start to July caused by less dovish Fed expectations after the June jobs report.

Speculators lifted their net long position in Comex gold for a fifth straight week over June 25-July 2.

ETF investors bought gold at a modest pace during the first week of July.

As recession fears grow, haven demand for gold is likely to increase in the coming months.

China’s central bank appetite for gold was intact in June.

Introduction

Welcome to Orchid's Gold Weekly report. We discuss gold prices through the lenses of the World Gold Shares SPDR Gold Minishares Trust ETF (GLDM) because we think that is the best pure-play ETF to assert exposure to spot gold prices.

GLDM is off to a weak start to the month (-1%) after recording in June its largest monthly gain since the fund launched last year.

While the recent weakness in GLDM is primarily attributable to the stronger dollar caused by less dovish Fed expectations, after the stronger-than-expected June jobs report in the US, we think that buyers on the dips will re-emerge sooner rather than later because the late phase of the US economic cycle (where the probability of a recession in the US is now above 30%) will prompt investors to lift their demand for defensive assets like gold.

In this context, we level our target for GLDM at $14.55 per share by the end of July, which represents now an 8% appreciation from its current level.

Source: Trading View, Orchid Research

Speculative positioning

Source: CFTC, Orchid Research

Speculators lifted their net long exposure to Comex gold for a fifth straight week over the latest reporting period of June 25-July 2.

The net spec length in Comex gold increased by 70 tonnes over June 18-15, representing 4% of open interest and 2% of annual physical demand for gold. Over the corresponding period, gold spot prices rose modestly by 0.7%.

The net spec length is now at 43% of OI, moving closer to its historical high of 52% of OI established in July 2016.

Should speculators build a net long position as high as the historical high, this would imply additional speculative buying of 175 tonnes, according to our calculations. This would push Comex spot prices still higher.

Implications for GLDM: While gold's spec positioning is very long, it is not yet stretched on the long side in the sense, in which it is still less bullish than its historical high. As a result, there is some potential for further speculative buying in the near term, which would push the spot gold price higher, thereby benefiting the value of GLDM.

Investment positioning

Source: Orchid Research

Gold ETF holdings increased for a 6th week in a row last week, according to our estimates.

Gold net inflows totaled a modest 4 tonnes last week. This comes after a net monthly inflow of 92 tonnes in June, the largest since February 2017.

Gold ETF holdings are now at their highest level since May 2013, having increased by roughly 78 tonnes in the year to date.

Source: Orchid Research

Although gold ETF inflows have slowed since the start of the month, we think they will remain positive over the next 6 to 12 months, considering the increasing need among investors to deploy funds into defensive assets like gold to protect their portfolios against a recession.

The probability of a recession in the next 12 months rose to 33% in June from 29% in May, according to the New York Fed recession model based on Treasury spreads.

Source: New York Fed

This is the highest probability since the Great Recession in 2008. Historically, a reading above 28% has consistently led to a recession over the past 50 years. This reinforces our expectations for stronger safe-haven demand for gold in the coming months.

Implications for GLDM: As we are in the late phase of the US economic cycle, we think that inflows into gold ETF holdings will naturally increase in the coming months. Stronger monetary demand for gold will result in firmer spot gold prices, which in turn will boost GLDM's value.

Central bank demand for gold

The Chinese central bank (PBOC) lifted its gold holdings by 10.3 tonnes in June, after buying 74 tonnes in the first five months of 2019.

Source: World gold charts

Most central banks from the EM world have boosted their gold buying in recent months. In our view, this is the result of 2 factors: 1) the need to be less dependent on the dollar and 2) the need to gain investor credibility.

As this trend should continue, we think that central bank demand for gold will continue to grow in the coming years, which should offer some support to gold prices and thus GLDM.

Technicals

Source: Trading View, Orchid Research

GLDM is down a little bit more than 1% since the start of July after recording in June its largest monthly gain since the fund launched last year.

Although GLDM has faced some resistance at $14.50/share in recent days, the daily momentum is still positive, the ADX is above 21, and the 20-day moving average remains positively sloped. This confirms that the current trend in motion is strong and sustainable.

We see solid support levels at the 20-day moving average ($13.77) and the February high ($13.45). Any dips should, therefore, be eagerly bought.

We maintain our July target for GLD at $14.55/share, representing an 8% appreciation from its current level ($13.90).

Closing thoughts

Despite a weak start to July driven by less Fed dovish expectations after the stronger-than-expected US jobs report for June, we remain constructive on gold in the course of July. Although the dollar has moved strongly higher after the June jobs report, gold has proven resilient. This reinforces our thesis according to which the yellow metal has entered a bullish regime in which bullish news flow is more impactful than bearish news flow. As we expect stronger monetary demand for gold in the coming months, we see gold trading higher.

We maintain our GLDM target of $14.55 per share in July, representing an 8% appreciation from its current level.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Our research has not been prepared in accordance with the legal requirements designed to promote the independence of investment research. Therefore, this material cannot be considered as investment research, a research recommendation, nor a personal recommendation or advice, for regulatory purposes.