16 June 2016 at 13:00 GMT
Who's on board? The result of next week's Brexit vote will help
determine gold's direction. Photo: iStock
By Ole Hansen
Precious metals have benefited greatly from the market uncertainty ahead of the UK referendum on June 23. During May, both gold and silver succumbed to profit taking following a very strong beginning to 2016.
Weakness was driven by renewed dollar strength combined with Federal Reserve Chair Janet Yellen and her colleagues at the Federal Open Market Committee trying to reinstate a more hawkish tone with regards to the speed and frequency of future rate hikes.
These attempts to introduce a more hawkish mindset in the market were quashed on June 3 when a weaker-than-expected US jobs report sent rate expectations lower once again. This was followed up on Wednesday with a distinctive dovish statement following the latest FOMC meeting. The FOMC lowered its projection of its own interest-path with six members now only seeing one rate hike in 2016.
In addition to the changing outlook from the Fed we have also entered the run-up to the UK referendum and with the leave camp gaining momentum, the market has begun to reduce risk while seeking shelter amid the brewing storm.
Strong performances from silver and gold so far this month
The above table shows how June so far has presented an almost perfect storm of gold positive market developments.
While equities have suffered, sovereign bond yields have continued to contract with the yield on German 10-year bunds being the latest to hit zero earlier this week.
The potential leave vote does not only raise questions about the impact on the UK but also the contagion risk to the rest of Europe. Other countries, if given the chance, would likely also be showing scepticism towards the European Union.
Fading US rate hike expectations, falling stocks and rising volatility combined with collapsing bond yields and the general raised level of uncertainty have seen gold make a break through the high from early May. Due to the current weakness of the pound sterling we have seen XAUGBP reach the highest level in almost three years.
Demand for exchange-traded products backed by gold remain strong. Even during the correction in May demand continued to climb. Tactical traders using futures were the main culprits behind the selling witnessed in May where hedge funds reduced bullish bets on gold by one-third. With the sharp reversal seen this month, they have been busy rebuilding long positions and during the week ending June 7 they added 20%.
The big question remains what kind of impact the vote will have on the yellow metal. We view the risk reward as being skewed to the upside. A vote to leave the European Union would almost ensure a prolonged period of uncertainty where stocks could suffer and bonds continue to be sought. While it may also support the dollar thereby creating some headwind giving the negative correlation we see an increased risk that gold could be propelled towards $1400, the 2014 high.
A remain result would initially trigger a major relief rally across global stocks but with the dollar also likely to weaken and with global bond yields remaining compressed we see the downside risk limited to around $1250/oz.
Source: SaxoTraderGo. Create your own charts with SaxoTrader; click here to learn more
– Edited by Gayle Bryant
Ole Hansen is head of commodity strategy at Saxo Bank