Gold Demand Falters, Dollar Strength Surprises

By in
Gold Demand Falters, Dollar Strength Surprises

Three Data items today:

#1: Gold is down 5.4 percent YTD and 13.4 percent from its August 2020 highs, so let’s look at the World Gold Council’s latest data on global exchange traded fund flows. As a reminder, these products have been the marginal bid for the yellow metal since the pandemic started. Usually, it’s jewelry and a bit of bar/coin demand with central bank buying occasionally playing a factor in terms of tipping points. Now, only bar/coin demand is really running hot.

Here is the WGC chart for net physical gold ETF demand in dollar terms by month back to January 2019. The rightmost bar shows a total of $1 bn of net new demand from this source last month. The break down was: $300 nm out of North American based funds, inflows of $1.1 bn from European funds, and $200 nm of outflows from “Other”. Asian funds saw no net inflows/outflows.

Takeaway: gold prices are softer because, at the margin, US investors are selling physical gold ETFs. The size of the purple bar (North American demand) in the chart above correlates closely to gold prices. European investors, concerned about the euro’s weakness of late, may be able to offset US sales in coming months if their currency remains soft. Also, US investors may return to gold if inflation becomes more of an issue later in the year. Finally, jewelry demand should slowly come back online as global economies recover. Our bottom line remains unchanged: we recommend a 3-5 percent gold position in diversified portfolios.

#2: Speaking of recent euro weakness, let’s talk about that for a minute. A few datapoints to set the stage:

  • The euro rallied by 15 percent from the March 2020 lows to its early January 2021 highs (1.07/$ to 1.23/$). As we noted several times last year, the dollar always weakens after a crisis as the global economy recovers.
  • From that 1.23/$ level on January 6th the euro has recently weakened by 2.7 percent to 1.197/$. This obviously goes against the standard recovery narrative noted in the last bullet, hence all the recent attention.

The proximate cause for the euro’s weakness is the slow rollout of vaccines in the Eurozone, which is creating concerns over a double-dip recession in the region. Recall that we recently outlined that Europe’s response to the pandemic was to create PPP-like programs so employers would not lay off staff. Even with those measures, unemployment across the region was 8.3 percent as of December 2020 (latest data). Europe cannot afford a slow return to normal, but that’s the path it’s on right now. Against that backdrop, euro weakness makes sense.

To frame where the euro “should” trade, let’s look at how the currency has done versus the dollar on a year-over-year basis back to 2005:

You can see the pattern we described in the bullets above. The euro saw its largest post-Financial Crisis runs in 2009 (boxed above) and early 2011 (just before the Greek Debt crisis), and again in early 2018 (peak confidence in a global synchronized recovery). More recently, it was up 10 percent as of the end of January.

Takeaway: given the uncertainties over Europe’s future economic track, it would be reasonable to expect the euro to weaken another 5 percent to match the middle of the chart above (2013 – 2014, 0 – 5 percent strength). After the Greek Debt crisis EU GDP didn’t get back to +2 percent until Q1 2014. We certainly hope the Eurozone does accelerate vaccine rollouts and GDP bounces back, but right now investor confidence in that outcome isn’t great.

#3: We continue to track the offshore Chinese yuan, and the recent data here is also worth a mention. Simply put, the yuan has suddenly stopped appreciating against the dollar over the last month. From its weakest levels at the end of April 2020 ($/7.17), the yuan rallied 10 percent through the first week of January 2020 ($/6.45).

But since those early January highs, the yuan has gone nowhere as this MarketWatch chart shows:

Takeaway: the yuan’s stall is not as dramatic as the euro’s weakness, but it tells a similar story and one we’ve been discussing with you in various forms. How quickly countries and their economies recover from the pandemic will vary. For now, the US looks to be out of the blocks fastest and may still reap the benefits of taking a harder hit to its labor market last year than Europe, for example. But… 2021 is still young, and every country has a long way to go before they are truly back to “normal”.

Sources:

World Gold Council report: https://www.gold.org/goldhub/data/global-gold-backed-etf-holdings-and-flows