Federal Reserve chairwoman Janet Yellen’s speech at Jackson Hole over the weekend contributed to gold’s latest decline.
Yellen said the case for a US rate increase has strengthened, without specifying whether we would see one in September or December. The odds of a September rate rise have risen to 42 per cent, from 22 per cent a week ago, and the odds of a December rate hike soared to 65 per cent, according to Bloomberg.
Gold, as a hedge against central banks’ quantitative easing programs, fell.
It is interesting that Deutsche Bank’s commodity team put up a note on gold, reiterating its view that gold could be worth $US1700 an ounce.
Deutsche analysts Michael Hsueh and Grant Sporre argue that the balance sheets of the main four central banks (the US, China, Japan, the ECB) have expanded by 300 per cent since the beginning of 2005.
Over the same period as the aggregate central bank balance sheet was rapidly expanding, global above-ground stocks grew by 19 per cent in tonnage terms or about 200 per cent in value terms, they said.
“If we were to assume that the value of gold should appreciate to keep the overall value of the big four aggregate balance sheet equivalent to that of the value of the above-ground gold stocks, then gold should be trading closer to $US1700 an ounce,” the analysts said.
Deutsche went on to discuss when we would have a sell-off in gold: the brokerage points out the rate of the aggregate balance sheet expansion versus the gold price momentum highlights some interesting points.
First, the gold price is sensitive to the rate of the aggregate balance sheet expansion. Second, if the rate of gold price appreciation under or outperforms over a period, there is a subsequent period of the opposite.
There were two distinct periods over the past 10 years when this correlation broke down. This first period was during the global financial crisis, when gold was sold to meet liquidity requirements, despite a sharp increase in the US Federal Reserve’s balance sheet. The second period was during April 2013, when gold suffered one of its biggest falls over a period of two days. This occurred at the same time the Federal Reserve indicated that it would end its QE program, and when it was thought that the Bank of Cyprus would have to liquidate its gold holdings to meet debt obligations. Arguably the gold market has taken over two years to recover from this event.
“Our conclusion however is that as long as the central banks’ balance sheets continue to expand, the gold price should maintain some momentum,” the Deutsche analysts said.
So if history is any guide, an imminent rate hike alone is not sufficient condition for a sell-off.