- Those who bought in face of market complacency are now rewarded
- But after seven weeks of fund buying, gold isn't immune to contagion
- Rising real yields have so far had a limited impact on gold
Gold shines bright in a sea of red. Pic: Shutterstock
By Ole Hansen
I'll kick off this update by borrowing a section from my colleague John Hardy's FX update
which describes current developments very well:
"We’ll dispense with the normal daily news and talk about the elephant in the china shop for global markets, the meltdown in equity markets, led by US markets late yesterday and overnight. The key driver in this phase has been the classic 'negative convexity' problem that develops when markets have been too quiet for too long and volatility picks up. Those who have been short volatility or 'selling insurance' suddenly find that their assumed risk of 1 is a risk of 5 times that and then 10 times that as the gamma and negative convexity kick into effect.
Then come the margin calls and lack of liquidity as all of these actors try to squeeze out of the market at the same time. In this instance, the immediate driver or trigger was likely the stress testing of market’s set of assumptions about the Fed (slow and steady hikes) and about correlations (if equities sell off, bonds will offset some of the decline by rallying). Friday’s US jobs report broke that narrative with a strong earnings surge and surge in yields that also saw stocks selling.
Interestingly, this event has seen very restrained contagion across other asset classes, especially FX. That fact offers some hope that this is merely a washout of the most egregiously leveraged of actors in the volatility space and some piling on of algorithms as liquidity got severely pinched. But today is a critical test as the selling has to stop here if we are to label this whole episode a rogue wave rather than a tsunami.
Regardless, we are convinced that this event has been a game changer that has taken us out of the low volatility environment for now, even if risk manages a full recovery as models will have to be adjusted to take into account what has unfolded here."
Gold has traded relatively calmly during the bond and stock market turmoil this past week. Investors who bought gold in recent months in response to increased market complacency are now being rewarded by gold's – if not absolute – then at least relative performance compared with other asset classes.
The stock market slump triggered an aggressive jump in the VIX (aka the 'fear gauge') while reducing the expectations for future US rate hikes.
Gold, however, is not immune following seven weeks of fund buying. If the selloff continues and the contagion spreads, we could see general wide spread reductions in risk with leveraged players being met with additional margin calls.
Rising real yields, which last week spiked to 0.74%, a 13-month high, have so far had a limited impact on gold with the underlying rising inflation theme providing support.
Gold has traded within a down-trending channel since hitting a high on January 25. The bull flag formation this has created could signal a potential extension towards $1385/oz on a break above $1345/oz.
– Edited by Clare MacCarthy
Ole Hansen is head of commodity strategy at Saxo Bank