18 May 2018
Gold: How much worse before it gets better?

In our last note, we feared Gold's long-awaited breakout was going to be to the downside. Now this has happened we look to physical demand, geopolitics and inflation to provide support

Breaking below $1300/oz

Gold prices fell 1.5% on Tuesday 15 May, breaking below $1300 for the first time this year and ending what has been an incredible range bound for five months. 

At times it seemed as if the yellow metal is prime to spring higher, but after several failed attempts to meaningfully consolidate above $1350 and attract decent inflows this year, it was the rebounding dollar and the step up in yields that set the only remaining path: down.  

Gold's dull performance has indeed fatigued the long fund community for some time. Money manager longs were already reduced to just 109k lots by early May which is the lowest level since early 2016. We believe the USD rally from mid-April is symbiotic of a short squeeze rather than any change in fundamentals, but a surge of money managers that went short gold since the dollar turned suggests those funds saw things differently. The open interest had continued to rise after that which points to a continual short building right until the drop. Perhaps those speculative shorts were anticipating, like our rates team predicted, that as that dollar rally came off the boil, the US 10yr yield was free to break above the psychologically significant 3%.

We are under no illusion that rates and currencies direct gold above everything else, but the impact of a tightening physical market will play an increasing role to cushion these lows

As the 3% yield breach occurred on Tuesday, Gold’s non-yielding qualities were punished. Gold traders should expect more of the same headwinds for the next few months as ING strategists see yields on track to hit as high as 3.4%. But, with much of the fund longs already flushed out, growing inflation, geopolitical risk and a pick-up in physical demand should limit the downside. Things shouldn’t get much worse, but it will take time before we see improvement.

Looking at the options, it would seem the funds have the same dwindling near-term conviction but also hold out on further optimism. The 3-month premiums for calls over puts have collapsed even as prices fell but further forward the options markets are still pricing higher upside demand.

The Bank of England’s road to August in six charts

Will the UK economy emerge from the depths of the worst quarter of growth since 2012? That's the question Bank of England officials will be looking to answer between now and the August meeting

Markets may be underestimating rate hike risks - but it all depends on the data

After the May Bank of England meeting (BoE), markets remained unconvinced we'll see a rate hike this year. As we noted at the time, we think this looks like a bit of an overreaction based on what policymakers have been hinting over recent months. With wage growth on the rise, the chances of an August rate hike might be underestimated, and we still narrowly think a rate hike is more likely than not over the summer.

But this is certainly not a done deal. The high street is still having a particularly tough time, and contrary to the Bank’s statement last week, suggests more than just snow prompted at least some of the first quarter lull.

Either way, whatever the Bank decides to do in August will depend heavily on economic data between now and then. With 78 days until the August meeting, here’s a round-up of some of the numbers that policymakers will be keeping an eye on, and how we think they’ll move.

TTIP 2.0: A solution to the US-EU trade conflict

President Trump is about to unleash a trade war with the European Union if the EU does not meet his demand to take unilateral measures to lower the US trade deficit with the EU. The EU says it won't comply and has instead prepared a list of retaliatory measures. Both parties would be better off if they decide to resume the TTIP negotiations

The benefits of resuming TTIP

At the end of April President Donald Trump demanded trade concessions from the EU by the first of June, at the pain of raising tariffs on EU steel and aluminium. Countries such as South Korea have already yielded to the same blackmail tactics from the US government. Canada and Mexico are also prepared to make concessions in the ongoing NAFTA re-renegotiations and even China has made some concessions. 

Trump's blackmail strategy won't work with the EU

But the EU has held firm and asked the US to remove the threat of steel and aluminium tariffs before talking about changing the trade conditions. The EU is in a better position to issue this demand than other countries. South Korea, Canada, Mexico and even China are more dependent on US demand for their products than the other way round. In contrast, the US economy depends almost as much on European demand trade for its products than vice versa. A transatlantic trade war would lead to a lose-lose situation for both the US and the EU. 
Resuming the TTIP (Transatlantic Trade and Investment Partnership) negotiations, on the other hand, would bring benefits to both trade giants.

A free trade agreement is not only superior to the current strategy of Trump because he has difficulties strongarming the EU, so it would avoid a mutual harmful trade war, but also because such an agreement would result in larger benefits for the US then unilateral EU- concessions. After all, if the EU would give in to the US and reduce an import tariff unilaterally, for example on cars, WTO rules dictate that it needs to offer the lower tariff to all its trade partners. So all imported cars would become cheaper – including the very competitive ones from Japan, South Korea and China. This would act as a brake on any increase in American car exports to the EU. 

Doing this will require quite some resistance to be overcome. TTIP was put on ice in late 2016 after activists in Europe had undermined support for the deal. On the other side of the Atlantic too, the political support for a deal had disappeared amid the apparent popularity of Trump’s protectionist campaign messages. 

Emerging markets: A test of nerves

Higher US interest rates and oil prices along with uncertain policy responses are weighing on the most vulnerable emerging markets right now. Investors seem to be sticking with the growth story so far, but will be looking for strong policy responses over coming weeks

Tough times for emerging markets

It has been a tough few weeks for emerging markets. Ever since the dollar started to surge from mid-April onwards, EM currencies and debt markets have come under pressure. Some of the most followed exchange-traded funds (ETFs) that track major EM debt indices are now down 5% year to date. And some of these funds are starting to see net outflows on the year.

For example, the iShares EMB ETF, which tracks hard currency debt issued by EM governments, has seen year-to-date outflows of US$50mn, versus US$1bn inflows over the last year. However, popular EM equity ETFs, such as the Vanguard FTSE EM ETF, continue to see inflows over the last week and year-to-date as well.

Emerging market currencies and debt markets might fare well if US rates rise more orderly amid a healthy global growth outlook. That said, investors will look out for strong policy responses

A firmer dollar and higher interest rates create challenges for those economies with large external deficits and also large budget deficits. Argentina scores poorly on both counts and after failing to restore confidence with aggressive rate hikes and suffering heavy losses in FX reserves, has turned to the IMF as a lender of last resort. An informal IMF meeting is scheduled for Friday this week, and expectations are that it will have to accept a fiscally tight policy in response to a multi-year programme.

Raoul Leering: Trump might have a point on China

Watch Raoul Leering, ING's Head of International Trade Research, talk about Trump, trade and tariffs in New York

Reading time around 7 minutes

In Case You Missed It: Testing times

It's been a tough few weeks for emerging markets but will a more orderly US rates rise help? We illustrate Mark Carney's dilemma in six charts, and ING's head of international trade explains why President Trump's strategy won't work with the EU, but he might have a point on China 

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