Morning Note: Market news and our thoughts on gold.

Market News

US equities ended the week on a positive note – S&P 500 (+0.2%); Nasdaq (+0.2%) – extending their advance into a seventh straight session, with the S&P 500 seeing its best performance in such a span since October 2022. Hedge funds started buying US equities toward the end of last week after better-than-expected retail sales data and positive earnings helped allay growth concerns, according to Goldman’s prime brokerage data.

The Fed’s Mary Daly told the FT she has “more confidence” that inflation is under control and it’s time to consider adjusting borrowing costs, but the economy is “not in an urgent place.” Gold hit $2,500 an ounce (see below), bolstered by hopes of rate cuts, while the 10-year Treasury yields 3.87%. The focus this week will be on Jackson Hole, Wyoming where central bankers will meet to discuss the economic outlook and monetary policy.

In Asia this morning, stocks advanced – Hang Seng (+0.8%); Shanghai Composite (+0.5%) – led by a rally in Hong Kong technology shares, while hopes of lower US interest rates pushed the region’s currencies to the highest level in five months against the greenback. The main area of weakness was Japan (Nikkei 225, -1.8%) driven by renewed strength in the yen which is back above 146 versus the dollar.

The FTSE 100 is currently trading 0.3% lower at 8,302. The number of potential UK home buyers who contacted agents to view properties jumped 19% this month from a year earlier, Rightmove said. British companies stepped up advertising for jobs last month for the first time this year, data from Adzuna showed. Sterling remained firm at $1.2963 and €1.1737.

Kamala Harris holds a lead of 49% to 45% over Donald Trump, according to a Washington Post-ABC News-Ipsos survey. A NYT/Siena College poll found that the ex-president trails the VP in Arizona and North Carolina ahead of today’s start of the Democratic National Convention.

Source: Bloomberg

Commodity Update – Gold

Ongoing geopolitical tension and an expectation of monetary easing in the US have helped to push the price of gold above $2500 an ounce, an all-time high. So far this year, gold is up an amazing 22% in US dollar terms, with the return for a UK-based Sterling investor not much behind.

Gold priced in US dollars over the last five years.

Source: Bloomberg

We have previously highlighted that gold – in fact all precious metals – tends to be either completely overlooked or given a minimal allocation in investors’ portfolios.  However, they possess many diversifying qualities that should not be ignored.

Gold is unquestionably the most important metal within the precious metals complex.  Gold plays a unique role in the financial system.  All of the major central banks that issue the currencies that are broadly regarded as “money” in their various jurisdictions, hold it to varying degrees.  It is generally the only asset they hold that is not the liability of another entity.  Under banking regulations, it has a zero-capital requirement, which means banks can hold it without setting aside any capital against it.

To this end, gold can be viewed as non-interest-bearing money (a disadvantage relative to central bank issued fiat currency), but money that cannot be devalued in any meaningful way by the actions of central banks (an advantage relative to central bank issued fiat currency) and to this extent it is a contra-currency.

Historically, gold has traded inversely to the real yield on risk-free sovereign debt.  The theoretical underpinning of this relationship is that the higher the real yield (nominal yield, minus inflation) on the fiat asset, the less attractive gold and vice versa.  The chart below shows this relationship held for most of the last 20 years but broke down dramatically in the last 2-3 years as real yields rose dramatically, and instead of falling as the prior regime would suggest, gold continued to march higher.

To understand what might be happening, we need to view gold not through the lens of the issuer of the world’s reserve currency (the US), but through that of an emerging market going through a currency crisis.  In this situation, the more policy is tightened, the worse the situation gets as the higher rates simply cannot be sustained by the economy and instead of rising versus gold (and other non-fixed return assets denominated in that currency, such as equities), the currency falls, often dramatically as the only way to meet its liabilities is through the issuance of more currency.

The de-coupling of gold in US dollars from real rates is a sign that the market is calling into question the ability of the US to sustainably maintain meaningful positive real rates given its current debt dynamics.  If you are sure it can, then you should bet against gold.  If you are sure it can’t, you should make gold the main holding in your portfolio.  Given that none of us can be sure about anything, a large enough position to benefit from gold’s convexity in more extreme outcomes, seems like the way to go.

We also notice that the gold mining sector, represented in the chart below (RHS) by the VanEck Gold Miners ETF, has been a disappointing performer relative to the underlying commodity. The sector peaked in 2020 when the gold price first climbed above $2,000 an ounce, since when it has dramatically lagged. Given the degree of operational gearing inherent in the mining business, this is not what we would have expected. While there are operational, financial, and political risks to consider when holding the shares of a gold mining company, these can be diversified away, in part, by holding a portfolio of stocks or through an ETF.

Only very recently has the sector started to play catch-up – we expect this trend to continue.

Gold versus the Gold Mining Sector.

Source: Bloomberg