Gold Weekly: Shining On Macro Uncertainty

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About: GraniteShares Gold Trust (BAR)
by: Orchid Research
Summary

Gold prices continue to shine amid macro uncertainty caused by escalating trade tensions.

Speculative funds look overextended on the long side, prompting us to stay cautious in the immediate term.

Although we believe that the current macro environment is conducive to stronger safe-haven demand, we would not be surprised to see a temporary sell-off in gold prices by month-end.

BAR: We are now on the sidelines after our monthly target of $14.55/share was hit in the first trading week of August.

Introduction

Welcome to Orchid's Gold Weekly report. We discuss gold prices through the lenses of the GraniteShares Gold Trust ETF (BAR), which replicates the performance of gold prices by holding physically gold bars in a London vault in the custody of ICBC Standard Bank.

BAR has continued to really strongly since our previous weekly publication, up already 6% on the month, as safe-haven demand surges in light of the latest escalation of the US-China trade dispute.

While our August target of $14.55 per share was reached in the first trading week of the month, we now prefer to stay on the sidelines as spec positioning becomes too stretched and conducive to possible bouts of profit-taking by the end of the month.

We would take advantage of a sudden sell-off in BAR to reassert upside exposure to the yellow metal.

Source: Trading View, Orchid Research

About BAR

BAR is directly impacted by the vagaries of gold spot prices because the Funds physically holds gold bars in a London vault and custodied by ICBC Standard Bank. The investment objective of the Fund is to replicate the performance of the price of gold, less trust expenses (0.20%), according to BAR's prospectus.

The physically-backed methodology prevents investors from getting hurt by the contango structure of the gold market, contrary to ETFs using futures contracts.

Also, the structure of a grantor trust protects investors since trustees cannot lend the gold bars.

BAR provides exposure which is identical to established competitors like GLD and IAU, which are nevertheless much more costly to hold over a long period of time. Indeed, BAR offers an expense ratio of just 0.20% while IAU and GLD have an expense ratio of 0.25% and 0.50%, respectively.

Speculative positioning

Source: CFTC, Orchid Research

Speculators lifted remarkably their net long exposure to Comex gold in the week to August 6, after three weeks of muted activity.

The net spec length increased by 6% of OI over July 30-August 6 to 49% of OI. We are getting very close to the historical high of 52%, suggesting that positioning is now stretched on the long side and there is little room left for additional speculative buying.

Other market participants need to take the baton to push spot gold prices higher as speculators are unlikely to boost markedly further their buying for Comex gold.

Implications for BAR: There is an elevated risk of net speculative selling on the Comex, which if materialized, could push gold spot prices lower, which in turn would exert downward pressure on BAR.

Investment positioning

Source: Orchid Research

ETF investors bought a strong 30 tons of gold in the week to August 9, pushing the monthly pace of buying to 81 tons (from 48 tons in the prior week).

Gold ETF holdings - at 2,285 tons - are at their highest since April 2013, having increased by 155 tons or 7% in the year to date. Investor sentiment toward gold has shifted positively since late April.

The increasingly negative yield environment has prompted investors to rebalance their portfolios toward gold since the yellow metal offers no yield (better than negative yield) and no counterparty risk (contrary to a sovereign bond). There is a clear positive co-movement between gold spot prices and the aggregate debt yielding negatively, as the chart from our friends at Nordea illustrates elegantly.

Source: Nordea

Given the dovish monetary policy shift by the Fed, we expect monetary demand for gold to continue to increase in the coming months, which should translate into steady inflows into gold. The main downside risk to investment demand for gold is a resiliently strong dollar, which would dampen demand in the world ex-US.

Implications for GLDM: As haven assets become increasingly bid at this stage of the cycle, we expect strong ETF buying for gold, which will support gold spot prices and therefore push BAR higher.

It's all about the yuan

The latest escalation of the US-China trade dispute has pushed the yuan below the psychological level of 7 to the dollar since the start of August, producing a sharp risk-off environment.

Strategists at Nordea believe that 7.30 is "an important line in the sand", which if broken, could produce a full panic in risk assets.

Source: Nordea

At present, while the PBOC has stepped up to support the yuan (instead of underpinning its depreciation as the US government seems inclined to believe), the yuan is fluctuating between 6.90-7.30, suggesting that the market is vulnerable to episodic sell-off moves.

Source: Murenbeeld & Co.

The yuan could weaken further, in our view, mainly due to the ongoing pressure exerted by the US on China, prompting market participants to revise more negatively their expectations for Chinese economic growth. As such, this macro environment tends to boost safe-haven demand, which is therefore gold-positive.

Closing thoughts

Cognizant that the current macro environment is conducive to stronger safe-haven demand, we believe that the upside potential for BAR looks limited for the rest of the month, as BAR has already delivered a positive performance of 6%.

We believe that speculative funds are too extended on the long side and therefore, gold is vulnerable to a sudden de-grossing, which could push prices temporarily sharply lower.

In this context, we think that it is wise to stay on the sidelines and await any sell-off before reasserting upside exposure to the yellow metal.

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.