MARKET UPDATE – July 2022
Inflation Running Hot – Why is USD Gold Price not Going Up?
While gold prices denominated in euros and yen have advanced 12.24% and 18.90%, respectively ytd, the USD gold price is lagging investor expectations. Why? First off, the global dash for U.S. dollar liquidity has weighed on the USD gold price in 2022 along with expectations the Fed’s hawkish stance on inflation will succeed in breaking the back of inflation. Secondly, we have seen a precipitous sell-off across the metals complex in response to recession expectations, with precious metals getting swept up in the sell-off. In our opinion, we are in the prelude period to a massive flow of capital that will be searching out a store of value as central banks, specifically the Federal Reserve, weigh the political and systemic risks of a global recession versus aggressively tackling inflation.
Federal Reserve – The Blink
We believe the Fed’s history of socializing market risk through extraordinary monetary policy (Fed balance sheet expanded 10 times since 2008) over the last 20 years shows it is more fearful of systemic financial risks than inflation. The yen and euro are down versus the USD and gold precisely because the Bank of Japan and European Central Bank have foregone joining the Fed in tightening for fear their respective economies are too fragile to withstand higher rates despite elevated inflation. At the first hint the Fed has acquiesced to political and market pressures to ease its hawkish stance, we believe its institutional credibility will come into question sending global investors scrambling toward gold assets.
U.S. Dollar – 20yr Highs = Forex Potential Crisis Looming?
The Fed’s hawkish inflation stance has attracted dollar demand sending the U.S. Dollar Index (DXY) to 20-year highs. The two main DXY components, the yen and euro have dropped 20.62% and 11.69% respectively, year to date. The strong dollar is compounding pressure on food and energy globally. The clock is ticking, in our opinion, on how much longer the global economy and policy makers can tolerate a strong dollar without attempting some type of coordinated accord. Street protests in Ecuador and Sri Lanka protesting higher food and energy costs are examples of the mounting social pressure spreading the globe.
Precious Metals Equities Suffer Tough Three Months
After peaking April 18th up 29.33%, the XAU has crashed to being down 16.53% year to date. Fear of operating cost inflation along with gold prices declining $122.70 over the past 60 days has led to what we perceive as extreme fears of margin compression. Additionally, short sellers have piled into the space playing up cost and capital inflation theme. The Gold/XAU ratio is the highest it has been in over 2 years at 16. In March 20—the gold / XAU ratio stood at 12.00 and prior to the 2008 GFC the ratio was 4.58.
Counter Intuitive Gold Price Action
- G-7 Bans Russian gold production from Western markets – gold price drops $100 over the following three weeks. Russia is the number three global gold producer at 300 tons per year. In theory removing 10% of global gold production from the market should be price positive. Granted, Russian oil finds its way to market in India among other markets, perhaps it is reasonable to believe the gold market assumed the same.
- Each inflation print over the last couple of months coming in at 40 year highs is met with the gold price getting monkey hammered lower on the announcement. It would not be unreasonable to believe there is official intervention taking place in the gold market to lower inflation expectations. Interestingly, JP Morgan and Citigroup recorded an approximate 10-fold increase in precious metals derivative exposure in the first three months ($28b to $330b).
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The Fund invests in gold and other precious metals, which involves additional risks, such as the possibility for substantial price fluctuations over a short period of time and may be affected by unpredictable international monetary and political developments such as currency devaluations or revaluations, economic and social conditions within a country, trade imbalances, or trade or currency restrictions between countries. The prices of gold and other precious metals may decline versus the dollar, which would adversely affect the market prices of the securities of gold and precious metals producers. The Fund may also invest in foreign securities which involve greater volatility and political, economic, and currency risks and differences in accounting methods. The Fund is non-diversified, meaning it may concentrate its assets in fewer individual holdings than a diversified fund. Therefore, the Fund is more exposed to individual stock volatility than a diversified fund. Prospective investors who are uncomfortable with an investment that will fluctuate in value should not invest in the Fund.
XAU Index is the Philadelphia Gold and Silver Index. It is an unmanaged capitalization weighted index composed of 16 companies listed on US exchanges involved in the gold and silver mining industry.
HUI Index also known as gold BUGS index is the NYSE Arca’s index measuring gold companies that do not hedge their gold production beyond a year and a half.
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