September was supposed to be the golden month. Macro indicators pointed to tailwinds for the yellow metal. The big one, of course, would be the Fed cutting rates. Typically, lower interest rates makes gold comparatively a better investment, making its price rise. Markets are also in risk-off mode, which would imply higher interest for safe havens. Yet, despite the market falling at the start of September, gold not only didn’t rebound, but has underperformed. What gives?
One of the factors is the nuances around gold as a safe haven asset. While it’s a great store of value for the medium and long term, it’s often not a very good hedge against short-term volatility. And that’s what has been pushing markets around lately. August’s “flash crash” saw volatility spike and then return in a matter of days. Nvidia’s stock price drop (the biggest single value loss for a company in history) last week spread into to the rest of the markets. But isn’t a medium to long term trend. Yet.
Draining Liquidity
When markets have these short-term pull backs, many investors have to pull liquidity from other assets to prevent themselves from getting margin called. One of the main sources for liquidity for those purposes is gold, which is why gold typically sells off when there is an unexpectedly strong pullback in the markets. But, the fact that investors are tapping into their “emergency reserves” is very concerning for the overall health of the market.
Typically, a market crash is preceded by conditions of tight liquidity. That’s because everyone is trying to sell, there aren’t enough buyers offering liquidity to match. This creates a feedback loop where lack of liquidity breeds lack of liquidity. By not being able to sell assets, the price drops, making more people want to sell those assets, which in turn means more people want to sell assets. Therefore, stock markets declining and gold falling in conjunction are particularly concerning signs for many traders.
What About a Recovery?
There’s more to the drop in gold prices than just liquidity. The price of the yellow metal is still higher for the year. The tailwinds that we discussed earlier were well telegraphed in advance. Meaning that the Fed rate cut is already priced into gold. What traders are now worried about is that the Fed rate cuts might have been overly priced in, and the path of easing might not be as steep as anticipated. This means gold could underperform in the short term.
Also, China has been a major buyer of gold, supporting its price over the last several years. Both the central bank has been stocking up, as well as private consumers. But, the faltering economy in China has caused that demand to dry up. The PBOC hasn’t been buying for a couple of months now, and retail buyers in China are slowing down.
Where To From Here?
A resolution of the underlying factors that have weighed on gold could mean it could rebound. If market losses stabilize, then liquidity could flow back into gold. If the economy in China improves, then so could the price of the yellow metal. If the Fed is more dovish than expected, then gold could also move higher.
But those are all ifs depending on how things perform in the future. We’ll have to wait and pay close attention to the data to see which way things break. One of the potential tipping points or relief moments could be the upcoming NFP, as that will likely determine market expectations for just how much the Fed will ease in the coming weeks.