Gold Market Commentary

July highlights

• As US dollar strength continued and inflation expectations softened, the gold price fell, gold ETFs lost 81t (US$4.5bn) and speculative positions in gold futures turned net short for only the fifth time since 2006.

Looking forward

• The market reaction to the July Fed meeting may encourage a more sustained fall in the US dollar and run up in risk assets. This could benefit gold but may also risk strengthening the Fed’s resolve. 
• Historical analysis suggests that current futures market positioning in gold, the US dollar and US 10-year Treasury combined could signal a good probability of positive forward returns for gold.

The dollar was strong and gold investment weak

Gold fell 3.5% in July, leaving it down 2.9% on the year at US$1,753/oz. ¹ A strong US dollar and sticky real yields weighed on gold in the first half of July. But softer inflation expectations mid-month and Jobless Claims a few days later in the US nudged the dollar and real rates down. These reversals also coincided with extended positioning in futures markets for currencies, gold and to a lesser extent, rates. Having faced a 6.2% drop mid-month, gold rallied to finish the month down only 3.5% (Table 1). 

Our Gold Return Attribution Model (GRAM) (Chart 1) suggests that gold’s performance was influenced by:

• Momentum: significant outflows from global gold ETFs and a further drop in gold futures positioning, reaching net short for only the fifth time since the series was introduced²  
• Risk and uncertainty: Weaker Brent crude prices on softer growth data and lower implied volatility also contributed to gold’s weakness
• Opportunity cost (FX): Continued dollar strength, which only reversed in the second half of the month 
• Opportunity cost (rates): Falling bond yields, on weaker growth expectations in the latter part of the month provided a boost to gold.

Table 1: Gold prices rebounded in the latter part of July but not enough to offset earlier losses 

As of 31 July 2022. Based on the LBMA Gold Price PM in local currencies: US dollar (USD), euro (EUR), Japanese yen (JPY), pound sterling (GBP), Canadian dollar (CAD), Swiss franc (CHF), Indian rupee (INR), Chinese yuan (RMB), Turkish lira (TRY), Russian rouble (RUB), South African rand (ZAR), and Australian dollar (AUD).

Source: Bloomberg, ICE Benchmark Administration, World Gold Council

Looking ahead…

• Expectations of a less hawkish US monetary policy environment and high investor cash allocations may weaken the dollar and trigger a more sustained recovery in equities and commodities. 
• In addition, our historical analysis of futures positioning in gold, the US dollar and 10-year Treasury bond suggests gold could further rebound further in the near future
   

A more sustained rally in equities and commodities

Nuance played a big part in the late-July FOMC meeting statement. An unusually large rate hike (+75bps) and consistently firm language on inflation was largely dismissed by markets. Instead, noting future data dependence vs forward guidance and the slim potential for a slower pace of hikes towards the end of the year, the dollar promptly sold off and equity markets saw some of the strongest one-day rallies since 2020.

The most recent Bank Of America (BoFA) fund manager survey, released more than a week prior to the Fed meeting, painted sentiment as ‘dire’ and the proportion of managers willing to take on more risk reached an all-time low. Also notable in the report was that cash as a share of total portfolio holdings was at its highest since 2001. Although causality isn’t clear, this may explain the dollar’s recent strength. 

It may also present an opportunity. After all, sentiment tends to mean revert. Extended positioning in the futures market coupled with a deployment of these cash allocations could give a boost to risk-asset inflows in conjunction with a weaker dollar.

But it could also backfire for markets and test the resolve of the Fed, who's belief is that bringing demand back into balance with supply is necessary to combat inflation. All in all, a weaker dollar would be welcome for gold investors, but a reflationary environment could be a headwind, especially if it led to the Fed reasserting itself.

Extracting signals from the futures market

In the middle of July, managed money positioning in gold futures turned net short for only the fifth time since the series was introduced in 2006 (Chart 2). We find futures positioning data a historically useful gauge of speculative sentiment in gold, particularly at the extremes.

Net shorts in gold futures have historically been associated with positive gold returns going forward. For example, on a three-month horizon, they have been positive 88% of the time, with this figure rising to 95% and 100% on a six month and 12 month forward basis, respectively.³  However, the rarity of a net short means that we have only a handful of observations on which to base our inference.

Alternatively, looking at standardised (z-score) positioning increases the number of observations (Chart 3). This adjustment provides more frequent and stable oscillations, as well as more compelling results. Our analysis suggests that when standardised managed future positioning is two standard deviations below its long-term average, forward gold returns are positive between 81% to 90% of the time across 3- to 12-month horizons, suggesting strong mean reversion in sentiment which can help drive gold higher.

In addition, we might also get a steer from positioning in some of gold’s important drivers: the US dollar and 10-year Treasury futures. Positions in the US dollar and US 10-year Treasuries are close to net long and net short extremes, respectively (Chart 4). ⁴ Historical analysis suggests that reversals from such extremes are common and they have overwhelmingly resulted in positive returns for gold in subsequent months.⁵

Combined, these metrics suggest that when their average positioning is below -50%, returns for gold have been positive 80-97% of the time over the following three to 12 months (Chart 5). We urge some caution here, however. Futures activity represents only a portion of total volume in the respective markets. As such these signals should be viewed in conjunction with other metrics.

Regional insights

China: China’s gold demand was robust in July. First, total holdings in Chinese gold ETFs saw a notable rise, mainly driven by opportunity-buying amid a lower local gold price combined with risk-off sentiment and higher safe-haven demand as the local stock market fell. Second, a rising monthly average Shanghai-London gold price spread, elevated physical gold trading volumes at the Shanghai Gold Exchange, and our conversations with gold manufacturers all point to stronger wholesale physical gold demand. For more details, please stay tuned for our monthly blog on China.

India: Retail demand remained tepid in July due to muted rural demand, the wedding season drawing to a close and the higher import duty on gold. Retail demand saw marginal improvement during the third week of the month due to a correction in the domestic gold price, however consumers held back purchases in expectation of a further correction to come. Wholesale demand saw decent activity as jewellers replenished stocks ahead of the India International Jewellery Show (IIJS), and this coincided with a correction in the local gold price.⁶  With healthy wholesale demand, the local discount narrowed to US$1-2/oz by month-end compared to a discount of US$23-24/oz at start of the July. 
Indian gold ETFs witnessed net outflows during the month (0.9t). Inflows were primarily driven by profit-taking amid a sharp correction in the domestic gold price and expectations of further price weakness 

Europe: With inflation expected to have reached a new all-time high in July, the European Central Bank (ECB) increased its policy rate by 0.5%, exiting its negative interest rates policy with the first increase in 11 years. The ECB also introduced a new debt crisis tool aimed at avoiding a surge in borrowing costs for vulnerable economics such as Italy, whose Prime Minister Mario Draghi resigned during the month amid political turmoil. But despite the continued less-than-rosy picture for the region, holdings in European gold ETFs sold off during the month (-38t), led by significant outflows in UK funds.

US: US Mint data shows that gold coin sales (American Eagle and Buffalo) totalled 104,000 oz in July, below the y-t-d average of 158,000 oz. Annualising current sales suggest that 2022 could surpass full-year 2021 sales of 1.6mn oz⁷,  reaching an estimate of 1.9mn oz. This would represent the strongest year of sales since 1999 (2.1mn oz). 

ETFs: Gold ETF net outflows totalled 81t in July, with y-t-d inflows of 153t (US$10.3bn) (Table 1). All regions except Asia experienced outflows during the month. North American funds led the way with 50t of outflows, followed by European funds (38t). Weaker gold performance, a stronger dollar and equity market, along with continued decreases in net long positioning in the futures markets likely drove these outflows. Total AUM in these products now stands at 3,708t (US$209bn).

Table 2: July 2022 Global ETF flows*

*Data to 31 July 2022. On Goldhub, see: Gold-backed ETF flows.

Source: Bloomberg, Company Filings, ICE Benchmark Administration, World Gold Council