Gold returns had another strong month, helped by expectations of a first Fed rate cut which drove the US dollar and Treasury yields lower.
Strong activity in gold options spread trades likely reflect a shift in expectations for interest rates and election risks in H2.
Following a strong monthly increase in July, gold posted another healthy gain in August to finish 3.6% higher at US$2,513/oz. It also reached a new all-time on 20 August before a very marginal decline into month end (Table 1).
According to our Gold Return Attribution Model (GRAM), gold was pulled higher by a material drop in the US dollar and, to a lesser extent, lower 10-year Treasury yields as the Fed signalled the time had come for rate cuts (Chart 1). The main identifiable negative contribution came from a momentum factor, the gold return in the previous month, i.e. when high, the following month typically sees a lower return and vice versa.
Also of note in August, the significant cut in import duty on gold in India, which took place in late July, has been a shot in the arm for gold demand in the country. Anecdotal reports suggest the duty reduction was followed by strong buying interest from jewellery retailers as well as consumers. Meanwhile, global physically-backed gold ETFs extended their inflow streak to four months. Western funds once again contributed the lion’s share of flows.
Performance of gold in various currencies*
| USD (oz) | EUR (oz) | JPY (g) | GBP (oz) | CAD (oz) | CHF (oz) | INR (10g) | RMB (g) | TRY (oz) | AUD (oz) | |
| August price | 2,513 | 2,275 | 11,811 | 1,915 | 3,391 | 2,135 | 67,774 | 573 | 85,644 | 3,715 |
| August return | 3.6% | 1.3% | 0.6% | 1.3% | 1.2% | 0.0% | 3.8% | 1.6% | 6.6% | 0.0% |
| Y-t-d return | 20.9% | 20.8% | 25.3% | 17.3% | 23.2% | 22.1% | 21.9% | 20.8% | 39.6% | 21.8% |
*Data to 31 August 2024. Based on the LBMA Gold Price PM in USD, expressed in local currencies.
Source: Bloomberg, ICE Benchmark Administration, World Gold Council
Globally, top line data still looks quite good. GDP growth is ticking along at 2.5% and composite PMIs remain positive. But services, which account for the lion’s share of output, are supporting those numbers and disguising the fact that manufacturing remains in a bit of a slump, particularly in Europe and China.
Zooming in on the US, the situation also appears to be in flux. Composite PMIs are mildly in expansion, mirroring the global picture. Retail sales have been upbeat, the stock market – following a mini lurch – keeps powering ahead, and consumer sentiment perked up recently.
On the flipside, unemployment jumped to 4.3% in July, a big enough leap to invoke the Sahm Rule,2 while loan delinquencies are rising fast, and leading indicators as well as the yield curve keep screaming recession.
A soft landing still looks the most likely outcome, particularly as Fed Chair Jerome Powell set the stage for a series of interest rate cuts in his annual address at Jackson Hole.
Short-term rate markets, for their part, were little changed after Powell’s remarks, having priced in nearly 100 basis points in cuts before the end of the year, suggesting they anticipate further weakening in the labour market. What is clear, as stated by Powell, is that the timing and pace of rate cuts will depend on incoming data, the evolving outlook and the balance of risks.
In other words, the Fed will have to navigate between pre-emptively avoiding a recession and the risk of inflation picking up again. The latter would arguably be far more damaging.
In this uncertain environment it is no surprise that investors have taken to the options market to hedge against, or speculate on, these seemingly binary outcomes, particularly given the tensions surrounding the US election in November. For instance, we continue to see elevated flows into equity options, which have now surpassed the previous all-time high back in Q4 2023.
This shift in investor behaviour is evident in the gold options market too. A normally benign and often overlooked corner of gold data is stirring.
Options spreading positions (OSP) within the CFTC’s Commitment of Traders report have been steadily rising, nearing levels not seen since 2019-2020, and before that, 2013 and 2011 (Chart 2). These positions are dominated by the “other reportable” category, which anecdotally is most likely to reflect the activity of Commodity Trading Advisors (CTAs), firms that focus primarily on price trends.
Looking back at those periods it seems the triggers for a rise in OSP activity were linked to one of two scenarios: either an interest rate policy shift (blue) or a market risk event (green).
We infer from these historical episodes that market event risks and policy rate shifts are likely drivers of a rise in OSPs.
Today, we face both. Markets expect the Fed to embark on a surprisingly aggressive rate-cutting path in September and we have a systemically critical US election in early November.
While the OSP data doesn’t reveal the nature of the spread positions, the difference in implied volatility (IV) at different maturities provides clues (Chart 3). This shows that short-term IV remains unusually high relative to longer-term IV plausibly reflecting the gravity of monetary policy and election developments of late.
We can also observe that this preoccupation appears predominantly bullish when looking at skew3 - measuring the difference in demand for calls relative to puts (Chart 4). Expectations of price rises appear to dominate hedging needs.
It is likely that the calendar spread reverts to its normal positive level if and when policy rate uncertainty wanes – likely following the September Fed meeting. Then election outcomes might start to dominate. But this, in our view, should maintain positive sentiment as conditions for gold remain positive regardless of which party wins, as we discussed last month.
We can only speculate on how broader macro data might influence market reactions, but it seems likely that both election dynamics and expectations of rate cuts have increased activity in gold, as seen in options ‘spreading’ positioning. Under these circumstances it is reasonable that investors are more focused on the near-term outlook. Their behaviour suggests that they view gold as a hedge against immediate event risks while also positioning it as a beneficiary of lower interest rates.
Outside of the US, the continuing slowdown in China is likely to impact consumers’ capacity and willingness to buy gold – certainly when it comes to jewellery. But even China’s gold ETFs saw outflows last month in contrast to the pickup in Indian ETF demand and welcome return of Western ETF inflows.
1A spreading position explanatory note can be found here.
2Sahm rule description can be found here
3Skew refers to the difference in how options are priced based on their strike prices. Put simply, it is the market’s way of showing whether people are more worried about the price going up or going down. More information can be found here.
