Gold has risen in recent weeks, to levels last seen in November, and at a time during
which US equities (S&P and Dow) are higher than last year. In fact, the S&P touched an
all-time high yesterday. Since March last year, gold has had a negative correlation with
the S&P. Even physical demand, mainly from Asia, as measured by our Standard Bank
Gold Physical Flow Index, is lower than in November and December last year.
Of course, it is well known that ETF gold liquidation has slowed substantially, and, for all
practical purposes, ETF gold holdings have been moving sideways since the middle of
January. ETFs have moved, from being a supplier of metal to the market since January
2013, to a more neutral factor in gold’s balance sheet. At the same time, short positions
in the futures market have declined, and new longs have entered.
However, key to us, and whether we are likely to see more ETF liquidation, is the 10-year
US government bond yield which has moved lower since the start of January, from just
above 3% at the start of the year to the current 2.74%. The decline in the nominal bond
yield has also translated into a lower real interest rate, as proxied by the 10-year US
inflation-linked bond yield which has dropped from just below 0.8% in December to the
current 0.56%. Gold traditionally has had a negative correlation with long-term US real
interest rates; a lower bond yield would imply a higher gold price.
Our G10 analysts continue to expect US bond yields to move higher towards year-end,
and the US 10-year government bond yield to move towards 3.75% by then. The rise in
the nominal yield, without many inflationary pressures, should also see real interest rates
rise. Unless the outlook for the US economy changes substantially, higher yields should
see more ETF liquidation. Therefore, we cannot get too bullish on gold yet, apart from
perhaps short-term speculative buying and short-covering, as we are witnessing at the
moment. A higher gold price, in our view, combined with a forecast of higher US bond
yields, could in fact attract more ETF liquidation. That said, we have pencilled in a more
sustainable, although relatively muted, recovery in the gold price in H2:14. This, in our
view, could be driven by demand from stronger demand from India once the current
account has recovered sufficiently, as well as ongoing buoyant demand from China (see
Commodities Quarterly dated 10 Jan 2014).

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