Gold bulls whose faith in the metal was rewarded earlier this year are being put to the test as a resilient rally in equities chips away at 2017’s gains.
Hedge funds are the most bearish on the metal in 18 months, and holdings in the biggest exchange-traded fund backed by bullion have plunged to the lowest since February. Gold has dropped more than 4% from an almost seven-month high in June, while equities have smashed through records and bond yields have climbed in the past month.
After building on last year’s gain that was the first annual increase since 2012, gold’s rally has sputtered. The same thing that’s helping equities is hurting the metal: stronger economic growth. That’s spurring more central banks to talk about raising interest rates, which curbs the appeal of bullion because it doesn’t pay interest. Gold bulls point to slow inflation and Federal Reserve concerns that asset prices look “somewhat rich.” A Bank of America Merrill Lynch survey showed fund managers growing hesitant to buy US equities.
“We’ve been in a non-stop bull market,” Jason Mayer, senior portfolio manager at Sprott Asset Management, said on July 14. “That has led to a lot of complacency, where managers are not hedging. Once that tide turns, that could prove to be bullish for gold and precious metals.”
Bullion’s share as a percentage of global financial assets dropped to 0.5% or $1.54tn last year from a peak of 0.9% or $1.96tn in 2012, according to CPM Group. That’s the value of physical gold held in bullion, which includes ETFs and gold coins. It doesn’t include gold futures or other derivatives. A move back to the peak market valuation reached in 2012 would mean about $420bn could return, according to CPM figures. With Fed officials signalling the US stock market may be overvalued, some traders are cautious about the outlook. Fed Governor Lael Brainard said July 13 that asset valuations look a bit stretched. San Francisco Fed President John Williams said last month that the stock market “seems to be running very much on fumes” and that he was “somewhat concerned about the complacency in the market.” Fed Vice-Chair Stanley Fischer suggested that there had been a “notable uptick” in risk appetite that propelled valuation ratios to very elevated levels.
According to Bank of America Merrill Lynch’s most recent fund-manager survey, allocations to US stocks have reached 20% underweight. The last time that percentage was greater was in January of 2008, when the S&P 500 Index was near its previous peak before crashing during the financial crisis. Investors said the Nasdaq Composite Index was the most crowded trade for the third straight month.
While a drop in stocks could boost demand for bullion as an alternative asset, hedge funds and other large speculators aren’t buying into the optimism. In the week ended July 11, money managers boosted their short position in gold to the highest since December 2015. Holdings in SPDR Gold Shares, the world’s biggest ETF backed by the metal, have dropped in four of the past five weeks, and were at the lowest since February 6 as of Tuesday.
When gold prices peaked in 2011, investors “were deeply concerned central bank expansion of the balance sheet was going to push inflation up very dramatically,” Tai Wong, head of base and precious-metals trading at BMO Capital Markets in New York, said in a telephone interview. “For people to look at gold aggressively as an asset class, you would need a global situation where we had greater levels of quantitative easing than we had the last time. Unless we see that, it’s difficult to see prices rebound to $1,900.”
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