Central bank action the past two weeks has been mixed for gold. The US Fed delayed lifting rates due to softer economic data (gold bullish) but the possibility of a rate hike in September still cannot be ruled out (bearish). The ECB did not expand QE (gold neutral, maybe bearish). The BoJ commented on the adverse consequences of a negative interest rate policy (gold bearish). Overall in the past few weeks there is a rising sentiment that the global central banks are not as aggressive as the market was hoping for and is starting to trade with a mini “taper tantrum”-like sentiment. Gold bullion, post Brexit, has been consolidating within an ABC corrective range with $1300 as firm support. Despite the back up in rates and currencies, gold bullion’s price action remains corrective. Gold closed this week at $1328 (+0.2%). We see $1300 as a key support level for bullion. Gold equities as measured by GDX corrected down to the $25 support level and re-traced about half of the decline before falling again on Friday’s mass sell-off. GDX for week closed at $26.41 (-3.4%). We see $25 as key support for GDX and GDX to more volatile and vulnerable than gold bullion in the next few weeks. 

It was a rough week for many asset classes. After months of some of the lowest sustained realized volatility in market history, the markets broke out of its complacency on Friday. The drivers of this sell off are once again the volatility control type funds (ie. risk parity funds, volatility funds, CTA’s, etc.). A few months ago post Brexit, volatility fell and these funds began to increase their position sizes. However once volatility picks up, they are programmed to start reducing their positions through trading algorithms and their position sizes are enormous. They generally do not scale in or scale out. These volatility control type funds are estimated to be $0.8 to $1.0 trillion AUM in size. A few years ago correlation patterns were considered an interesting factoid and did not have any real market implications. Today with the proliferation of these types of vol-control funds they have enormous market impact. 

As a reminder the market sell-off back in Aug and Sept of 2015 was created by these funds. The back up in rates that occurred on Friday started when the ECB decided not to expand its QE program further. This caused German yields to back up and US yields followed. Normally equities and bonds have a 30 day average correlation around -0.7. Recently this correlation has been +.35, the highest in the post 2008 world. Typically if equities sell off, bond yields would fall and gold would rise (gold as a safe haven). In this unusually extreme dislocation, most assets (not just gold) will likely see price movements that may appear “unexplainable”. For gold we expect this correlation-driven selling to be short lived (historically this has been the case, see chart below). As a reminder, the long term macro forces of this gold bull market have not changed. We are still in a negative interest rate environment. Once the equity/bond correlation reverts back to its normal range of -0.7 we would expect a significant rebound rally in gold equities in and around this correlation reversion. In the meantime volatility will be very high and difficult to predict. We mentioned a few months ago that post Brexit could see a change in correlation patterns, we just didn’t know until now.

The Gold Team
Paul Wong, Jason Mayer, Maria Smirnova, and Shree Kargutkar
Sprott Asset Management LP 

This is a chart of the rolling 30 day correlation between SPY and TLT.  Periods of positive correlations are very rare and typically do not last very long.  The 2013 period was the “Taper Tantrum”.

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