Rich cocktail sparks gold to three-week high

By Ole Hansen — old has risen to a three-week high following two days of gains despite some initial weakness on Tuesday driven by a stronger dollar. But, as the day progressed, it became apparent that the stronger dollar was being challenged and further support was provided by a sharp reversal in crude oil with WTI falling by more than 5 per cent in a matter of minutes.
This supported gold as it led to a reversal of earlier gains in stocks and losses in bonds.
Gold has a strong correlation with the Japanese yen and US real yields. Following the initial sell-off in US bonds in the aftermath of the US presidential election, we saw a big jump in US 10-year real yields from 0.11 per cent to 0.70 per cent. During the past two weeks, however, it has dropped back to 0.45 per cent thereby removing some of the pressure on gold.
The rapid yen weakness following November 8 also helped remove support for gold but during the past week we have started to see the correlation break down. As a result, gold priced in JPY has risen to an almost four-month high.
The wave of long-liquidation hitting gold, especially following November 8 continued right up until the end of 2016. Following seven consecutive weeks of selling, hedge funds held a net-long of 41,247 lots in the week ending December 27.   This was the lowest exposure since February 2 and some 35 per cent below the five-year average (2011-15). The net long has decreased 85 per cent since the July peak, with the gross short at a one-year high.
Gold ETP holdings remain elevated but were showing signs of stabilising last week. It remains to be seen whether this is driven by low end of year activity or investors having reduced exposure to the desired level.
Spot gold has been ticking higher since hitting a low on December 15 at $1,123/oz, the day real yields hit a high. Although the selling pressure may have eased, gold is still in need of a spark to change the sentiment.
Physical demand from China and India remains robust. In China demand is being driven by yuan-devaluation worries combined with Chinese New Year demand. In India, the cash crunch following the removal of high denominated notes has triggered safe-haven demand.
“Paper” gold buyers as mentioned above have been net-sellers for weeks and this segment is needed in order to shift the market sentiment back towards neutral. A break above $1,173/oz is likely to attract additional short-covering while real money buyers are likely to remain unconvinced unless it breaks back above $1,205/oz.
[The writer is Head of Commodity Strategy at Saxo Bank]