Gold Market Commentary: Under pressure

Looking ahead

• The US election results have taken a bit of a knee-jerk sting out of gold’s impressive y-t-d rally. Suggested reasons are a continued strengthening in bond yields and the US dollar, risk-on sentiment in equity markets, a boost to cryptocurrencies and a quelling of geopolitical tensions
• These factors might presage a welcome pause, even a healthy near-term retracement, for gold. 

There was a sense that the pre-election run up in Treasury yields and the US dollar might have been exhausted and that a turn in the dollar might lead bond yields lower – as it has done on several occasions over the last two years (Chart 2). After all, the dollar is richly valued on a real effective exchange rate (REER) basis¹ and a Trump administration is said to favour both a weaker exchange rate to encourage exports and lower interest rates to spur borrowing.²

However, the Republican sweep has gone hand-in-hand with an acceleration of the run up in yields and a quick reversal higher in the dollar index as well – driven by a sharp and nervous move lower in the euro and yen.

Turning our focus to the move in yields and the dollar. A confluence of factors are at play:

1. Positive US economic and inflation surprises (Chart 3)

2. Expectations of a Trump victory (Chart 4), with inflationary policies including tariffs, tax cuts, cuts to immigration and high levels of spending, are another factor. For example, infrastructure spending likely generates a GDP multiplier of about 1.4 vs tax cuts at 0.2.³ Trump’s policies sway towards the latter so debt might become an even bigger issue if not productive.

3. A rising term premium whereby investors saddled with US Treasuries need higher yields to be enticed into holding them (Chart 5).⁴

4. Overly dovish outlook as positioning in Treasury and US dollar futures had become somewhat stretched (Chart 6).

Added to the dollar and yield impact are concerns that cryptocurrencies are now currying more favour with the incoming US administration. And equity markets, particularly in the heavily weighted technology sector, have been given a further boost from expected ‘business-friendly’ policies.

Finally, murmurs that sanction risks might have been reduced given the incoming administrations purportedly less combative stance could also weigh on sentiment towards gold.

Yet despite these headwinds, we believe there’s still fundamental support for gold. And if it’s a retracement, we don’t expect it’ll develop into a rout:

• Gold has been taking fewer cues from US yields and the dollar of late with most of the returns in October (as well as during much of 2024) taking place during Asian trading hours. Some of this buying may have been ‘sanctions-related’, but central bank buying slowed in Q3 so it’s likely investor-led too. And now, Trump’s tariff policies have the potential to put more pressure on Asian equity markets. The weakness in China’s CSI300 index has been one factor contributing to stellar gold investment demand in the country during 2024
• The fiscal policies under a Republican sweep are likely to be inflationary: tariffs, immigration policy, tax cuts and a desire for low borrowing costs (although strictly, this fall under the independent purview of the Federal Reserve) have the capacity to weigh on inflation readings. In addition, excessive deficits will continue to exert pressure on the creditworthiness of US Treasury bonds, a suggested driver alongside sanction risks of global central bank gold demand⁵
• And for bond investors, c.4.5% nominal yield on offer for long bonds will probably continue to look insufficient, given inflation’s smouldering embers and the continued positive stock-bond correlation 
• Equity markets are already richly valued. Any adjustment to valuations from expected favourable tax policies should be priced in quickly. Should there be a cut to the CHIPS and Science Act,⁶ for example, that would likely result in a downward adjustment to the technology elements of the US equity indices. If the administration doesn’t roll back those expenditures,⁷ deficit concerns will continue to pose an issue and that is – all else being equal – gold friendly.

In summary

In summary, gold’s negative reaction to both the US election results and a continued move higher in bonds yields and the US dollar is in our view a near-term phenomenon. Other drivers including lower sanctions risks, a renewed bullishness in equity markets and cryptocurrencies mask the underlying – and in our view – more fundamental concerns of:

• A world where protectionism is likely going to be more acute and current conflicts see no signs of abatement
• Equity markets are heavily concentrated and richly valued during the end of a business cycle
• Cryptocurrencies continue to be a marginal consideration and not a replacement for gold
• Western investors have, outside of futures, not added much gold this year and so there is unlikely a slew of sellers in the wings.

Footnotes

¹The US dollar ranks at the 97% percentile relative to historical values since 1989 using the CITI real effective exchange rate index from Bloomberg.

²Trump Wants a Weaker Dollar. That Will Be Easier Said Than Done. - WSJ

³Investing around the election and debt issue | BlackRock

⁴The term premium and the bond vigilantes

⁵Goldman sees potential for gold prices surging above $3000 amid geopolitical risks by | Investing.com

⁶FACT SHEET: CHIPS and Science Act Will Lower Costs, Create Jobs, Strengthen Supply Chains, and Counter China | The White House

⁷Trump likely to uphold CHIPS Act despite his campaign rhetoric, experts say