Reasons for gold underperforming

Any hopes that US talks would come to a resolution over the weekend were short lived.

The disagreement rumbles on, with the blame for the slipped deadline now with Senate leaders. Some are describing this as crisis mode. Throughout all of this, gold has not behaved as a safe haven, as might have been expected. The heavy selling of gold caused Comex to halt trading for ten seconds on Friday on the back of a possible deal by the US lawmakers, but gold has not rallied once since the start of this crisis.

Gold’s performance

Clearly, the trend is biased towards the downside. Since the start of the year, gold has lost 24% of its value. The recovery from the end of June low of $1180, with August touching $1433, gave traders hope that gold might have bottomed out. However, the backdrop of subdued global inflation and weak physical buying saw a reversal of these gains. All things considered, it makes it hard for even gold bulls to be positive about the precious metal.

Some of the reasons gold performance has been lacklustre include:
1) the Fed’s accommodative stance being extended
2) the flight-to-safety choice has been Treasuries
3) the market doesn’t expect the US to default

One could argue that the continuous printing of fiat currency would see further depreciation, and that gold, as one of the few physical assets also considered as currency, would hold its value. Yet, since Yellen’s appointment, inflows to risky assets have continued, especially towards emerging Asian indices.

It would appear that market participants expect yield to remain in risky assets, and the return of equities will outweigh currency depreciation. The sell-off in August and September which erased the year-to-date performance has been all-but forgotten, with some indices - such as India’s - close to its year’s high, and the Philippines back with its double-digit return.

Diminished threat

Tapering, the cause of the exit of foreign funds into these markets with smaller market caps, is no longer such a big threat in the horizon, and the inflow of funds has been increasing at a steady pace. Economic data, which has been missing throughout the debt-ceiling debate, coupled with the impact of this tapering, would mean any possible action from the Fed to start the ball rolling is likely to begin next year at the very earliest.

Despite the risk that the US could renege on its debt payments, yields on US 10-year government bonds barely moved, while rates on shorter-term securities which mature in November and December moved higher. Fidelity, which manages $430b in money-market mutual funds, has taken precautionary measures and started selling short-term US debt that matures in November and December a couple of weeks ago, Bill Gross has taken the opposite view, advocating “buying what Fidelity is selling”.

This explains that, although rates on bills have risen, they pale by historical measures. As reported by the FT, there was a spike in CDS trading from the usual $2m in recent months to $200m in the past week, with traders taking out insurance policies against the possibility of the US government defaulting on its debt.

Yet the reassurance from finance chiefs holding Treasuries worth at least $1.3t is keeping the faith alive, as they expressed that there are no plans to sell, keeping the market from panicking. However, China, the largest holder of US Treasuries, has called for a new reserve currency to replace the US dollar, through its official press agency Xinhua and writer Liu Chang.

In the event of a default, it would be difficult to see how gold would not spike. However, given the poor performance and gold failing to break resistance levels despite the uncertainty looming, downside pressure will persist in gold. We expect prices to test $1250 this week.

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