Saturday, 9 September 2017

Euro Gold: a foreign perspective on the recent rally

There have been plenty of market comments on gold breaking above $1300/oz and holding on. Geo-political tensions on the North-Korean long-range missile launches and on nuclear tests - the last one with an H-bomb - predominated.  As we write September, raising the debt ceiling is another tough issue, possibly propelling gold.

The FED backing off from imminent rate hikes have been closer to reality. Especially since this has weakened the USD and propelled the Euro, which has a weighting of over 50% in the USD-index. The weakening of the USD has been the true reason of $1300 gold holding up.

In fact, when expressing the gold price in euro, this whole rally is quite underwhelming.

Gold  price  (1 ounce) in euro since 2017-Q2
By the end of the first quarter, the dollar rally had become a crowded trade. Not surprisingly, the USD rally got lead in its wings. Gold started 2017 Q2 at € 1176.  We did briefly see €1200 gold as the metal firmed towards mid April.  The metal slide towards May was aggravated by the euro drifting up from its support at around $1.05, initially towards $1.09 by early May. Gold seemed to find support at around €1120/Oz.

Interest rate advantage

It ought to have been clear by then that dollar parity of the euro was not in the cards any longer. There has been an interest rate advantage of about 2% on FED 10 Y treasuries relative to euro denominated government bonds of the less indebted countries of the union. This interest advantage for the dollar had driven down the exchange rate of the common currency since it peaked near $1.40 in May 2014.

Euro in USD since Jan 2012
For Europeans holding USD bonds there had been a 30% windfall profit, as there also was for US citizens or institutions betting against the euro. The common currency found support at $1.05 and more or less stayed in a $1.05 - $1.15 trading range since 2015 and until recently. The last bear raid on the euro failed late 2016. The tapering of ECB bond purchases tends to raise long term bond rates denominated in euro: the interest rate advantage is under pressure. Moreover, this is but a poor reward if the currency fluctuation reverses to your disadvantage.

The Trump stock market rally turns bleak when expressing stocks in euro or compensating the index values for the exchange rate fluctuation. The same accounts for the gold price...

Summer doldrums

The infamous summer doldrums for precious metals proved rather mild this year. However expressed against a firming euro, gold slid to €1060 early August. Only an acceleration of the gold price would prevent triple digit Euro-gold.

The yellow metal started its rally during the annual FED meeting at Jackson hole. Quite often this had been a difficult period for the gold price, as gold bears were scrutinizing the meeting proceedings for hawkish comments on behalf of FED directors.

Despite the ECB president Mario Draghi remaining vague about the tapering of the ECB bond purchases, the ascent of the euro continued unabated.  Despite gold near $1350 it only regains its former support level at €1120: exactly where we got to in May.

Miners lagging

Since gold ultimately left behind $1300, miners have rallied. Yet there was little enthusiasm, unlike the euphoria we witnessed in summer 2016.  Lately the HUI/Gold ratio struggles to uphold 0.16. This implies that miners are unable to outperform gold. The expected 'leverage' fails to materialize, causing much hesitation among gold mining investors.  By early September the residuals of the regression line HUI / gold prove the miners to lag by well over 30 points on the HUI index.  Last year the residuals were about equal in the opposite sense when the metals peaked early August.

Undoubtedly the lower USD is not favorable for the margins of most miners having their costs in foreign currencies. If you need any rationale to account for miners collectively lagging the metals, this is it.

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