Market Stutters and Safe Havens

Gold has shone since I last published, as I’m sure you all noticed.

The gain is nicely noticeable on a 30-day chart. Not to be negative, but things do look a little different on a six-month chart.

The summer decline was long and steady. And then it flattened out – in fact, in the last 2.5 months the price of gold has barely changed!

Against that, this week’s gains do matter, from a chart-ist perspective. What also matters is that gold gained alongside the US dollar and US bonds. For that to happen, for gold to gain even as the currency it is priced in is also rising, shows that investors really felt the need for safe havens.

I’ve noted recently that I thought the idea that gold was falling out of favour as a safe haven was overdone. Instead, I just think there hasn’t been a lot of demand for safe havens at all. After all, the stock market has continued to march up, economic data has been mixed but positive, and geopolitical tensions have been less rather than more dire. Of course Trump and trade wars are concerning, but against all those definitive positives investors are having trouble believing or reacting to the idea of a significant global trade war.

And so they haven’t needed safety. Until now…or last February…or mid-March… Bull markets don’t die of old age, but in alignment with other forces (high valuations, caution, inflation) they do start to stutter. This week saw a fairly serious stutter, with the S&P losing 2.6% last Thursday.

Against those declines, the USD gained 0.4%, Treasuries gained (yields declined), and gold rose 2.7% to best US$1,220 per oz. for the first time since July.

That, my friends, is safe haven action.

I think these stutters will continue. Each one will increase safe haven buying. If a series of stutters draws the market down notably, gold will gain even more. According to CitiBank, since the 1987 stock market crash, a decline of 12% or more in the S&P 500 over any three-month window has boosted gold prices by 7% on average over the same period. And gold has held those gains over the next three months.

Stutters will come from the usual concerns about high valuations and limited breadth and the age of the bull, but there are additional forces pending. The US midterms are certainly one; a blue wave would increase market uncertainty. Oil prices are also rising; a winter price spike would boost anxiety and drive investors to gold.

Specific to gold, there’s also an interesting hedge fund short position. Hedge funds are record short in their gold positioning at the moment, with fund gross long-short ratio having hit an all-time low of 0.5x this week. The historic average is 13.7x. If that sounds unusual, it is – the speculative community has never held such a lopsidedly bearish net gold position. (The chart below only goes back 3.5 years so it doesn’t illustrate the historic significance, but it does highlight how unusual the short position was even in a short-term context.)

As gold rises, these funds need to cover their short positions (their bets on the price of gold falling). Such ‘short covering’ can fuel a price rally, as the way to cover a short position is to buy gold.

And it’s not just gold itself that funds have shorted: short sellers have also gone crazy on gold stocks since mid-summer. They did so because gold was faring poorly, but also because Vanguard announced a restructuring of its Precious Metals and Mining Fund. The fund has been renamed – the Global Capital Cycles Fund – and will hold only 25% mining stocks, down from 80% before.

That change meant Vanguard had to sell mining stocks, significantly, from late July to the end of September when the rebalancing was completed. The news of this happening was like a field day for short sellers: expecting the mining stocks in Vanguard’s fund to slide because of the selling, they shorted those stocks. Short positions in Barrick Gold, for instance, shot up from 9 million to 39 million in the three months.

As it turned out, Vanguard finished its restructuring at the start of October…and soon after gold got some support. Some of that support came from ETFs, which switched to net buying from net selling two weeks ago.

The combination has generated a marked recovery in the TSX Gold Index.

This kind of action will continue. The more often the markets stutter, the more safe havens will shine. It’s a balancing act – I don’t want nor do I foresee a major market crash – but topping action and volatility are likely to hang around. And if they do, we’ll have lots more weeks like the one that just passed.