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Is This What Has Kept Gold Prices Low?

Gold

Gold has badly underperformed major asset classes in 2018, with prices down eight percent in the year-to-date compared to an 8.3-percent gain by the S&P 500. And a key reason for the weakness is a record pace of dumping by fund managers.

Indeed, fund managers have been dumping gold at a pace not seen since December 2016, and Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch says there’s been $7 billion in outflows over the past three months alone, Business Insider reported.

CFTC data shows that hedge fund managers have never been this pessimistic about gold since 2006. CME managed money net-long positions have hit their lowest in 12 years while net-long positions turned negative in August for the first time since 2001.

(Click to enlarge)

Source: Business Insider

Gold has weakened this year alongside many EM currencies due to rising bond rates and a brawny dollar. On August 13, gold fell below the key technical level of $1,200 per ounce to a 20-month low of $1,185.

That’s quite contrary to expectations since gold is usually favored as a safe haven during times of turmoil such as the ongoing global trade tensions.

Lower Bond Yields Favor Gold

Interestingly, traders have been betting against U.S. Treasuries, which is an indirect vote of confidence in gold since the two tend to move counter to each other. Hedge funds have placed record bets against 10- and 30-year Treasuries--so much so that Jeff Gundlach, the self-styled  bond king, has warned of an impending short squeeze.

(Click to enlarge)

But so far traders have been proven right, with the 10-year peaking at three percent before retreating to 2.848 percent. Related: Risk Emerges As Chinese Real Estate Defies Regulators

The backpedaling came after the ECB said that it intends to keep rates low until the summer of 2019. Negative rates in the EU and Japan make U.S. yields look attractive despite the fact that they are still way below their historical averages.

(Click to enlarge) 

Source: CNBC

Falling bond rates have dragged the dollar down, which has declined 2.5 percent over the past week. Trump’s rant against the Fed’s hawkish stance has no doubt also helped take down the greenback.

(Click to enlarge)

Source: Investing.com

As expected, a weakening dollar has worked in gold’s favor with prices climbing 2.5 percent over the past week.

Source: Investing.com

Delicate Balancing Act

It therefore appears that bond yields are the elephant in the room that will largely dictate the direction that safe haven assets like gold take. So, the big questions is whether rates will remain low as per the expectations of most traders or whether they will stage another huge rally to the detriment of the yellow metal.

Ten-year Treasury yields have surged from 1.85 percent just before Trump’s election to 2.6 percent shortly thereafter in anticipation of tax cuts and stronger growth, before stagnating again. Yet the reality is that yields should be considerably higher than their current levels.

On Friday, Fed chair Jerome Powell told the market to expect a diet of slow but steady rate increases, saying the economy is strong enough to support higher rates.

But it’s going to be a delicate balancing act for the Fed. History shows that disaster has usually followed episodes when the difference between nominal GDP and sovereign bonds was persistently negative--as it is right now. This includes the hyperinflation era of the 1970s, the Dotcom bubble at the turn of the Millennium, and the run-up to the 2008 financial crisis.

With that in mind, there’s a big risk that the central bank could consider unwinding its balance sheet faster down the road in order to prevent the economy from overheating.

(Click to enlarge)

Source: Berenberg Capital Markets LLC

But in the meantime, gold traders can hope that the record short positioning will lead to a nice short squeeze and propel prices higher.

By Alex Kimani for Safehaven.com

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