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Weekly Fundamentals - Gold's Rally Driven by Fall in Yields and USD, and Geopolitical Tensions Print E-mail
ONG Focus | Insights | Written by Oil N' Gold | Fri Sep 08 17 22:58 ET

The breach above US$ 1350/oz on Friday has brought gold price to the highest level in 13 months and is approaching a key resistance – the 2016-peak. For a third weekly rally, the benchmark Comex gold contract gained +1.63%. The yellow metal has rallied +17% since the beginning of the year and the upward momentum has accelerated since July. We believe the major reasons sustaining gold's strength include falling US Treasury yields, a weak US dollar and heightened Korean peninsula tensions. Others in the precious metal complex also strengthened with silver gaining +13% since the beginning of the year. In PGMs, palladium price has jumped +40% while that platinum has risen +13%.

Gold price and US Treasury yields have high negative correlation, as the following chart demonstrates. The rationale behind is that as US yields fall, the opportunity cost of owning gold, a non-interest bearing asset, is reduced. Moreover, gold price rises ahead of recession as investors choose hold gold as a store of value. While the US economy has been improving and is unlikely to enter recession, falling interest rates indicate that the growth momentum might be slowing. Indeed, Treasury yields reflect of expectations of the central bank's monetary policy, with yields rising on heightened hopes of a rate hike, and vice versa. In the US, hopes for a third rate hike this year have diminished over the past months due to subdued inflation. The negative impacts of Hurricane Harvey and Hurricane Irma might weight further on the economic outlook. Although Trump has surprisingly reached a deal with Democrats to extend the debt limit for three month, the risk of a government shutdown by the end of the year remains. This would continue to weigh on Treasury yields and the greenback.

The USD-dominated gold is also inversely correlated with the greenback. While gold has soared +17% year-to-date, the DXY index has plunged -10% during the period while the greenback has been down -14% against the euro. the chart below shows that the inverse correlation between gold and US dollar has increased over the past few years. We believe the relation was derailed as the Fed adopted ultra accommodative monetary policy after the breakout of the global financial crisis in 2008. QE began in December 2008 with the third stage ended in December 2013. The Fed funds rate had stayed at historically low level until the rate hike in December 2015.

Escalation of North Korean tensions over the past months has raised demand safe-haven. This has not only driven gold price higher, but also the values of Japanese yen and Swiss franc.

Oil Prices

Crude oil prices recovered last week, while gasoline price plunged, as refineries gradually resumed operations at the Gulf Coast. However, the market should focus now on Hurricane Irma which is approaching Florida. The EIA issued a report warning that Hurricane Irma may cause problems for East Coast energy infrastructure, including oil refineries, power plants, and major electric transmission lines.

While the impact of Harvey on the economy remains uncertain, the latest reports suggest that it appears to have resulted in higher than expected increase in oil inventory. The EIA reported that total crude oil and petroleum products stocks jumped +7.03 mmb to 1310.42 mmb in the week ended September 1. Crude oil inventory rose +4.58 mmb to 462.35mmb with stocks increasing in ALL PADDs. Cushing stock gained +0.8 mmb to 58.03 mmb, while utilization rate plunged -16.9% to 79.7%. For refined oil products, gasoline inventory increased +3.2mmb to 226.74 mmb as demand decreased +6.94% to 9.16M bpd. Production slumped -10.23% to 9.52M bpd while imports fell 43.39% to 0.48M bpd during the week. Distillate inventory decreased -0.94 mmb to 147.77 mmb as demand was up-3.91% to 4.06M bpd. Production slipped -11.14% to 4.49M bpd while imports sank -30.95% to 0.11M bpd during the week. The industry-sponsored API estimated that crude oil inventory gained +2.79 mmb in the week ended September 1. For refined oil products, gasoline stockpiles dropped -2.54 mmb, less than expectations of a -5 mmb decline, while distillate slipped -0.3 mmb. The market originally forecast that crude oil inventory rose +4.02 mmb for the week. Stockpiles for gasoline and distillate dropped -5 mmb and -3.06 mmb respectively.

As noted in the latest Beige Book prepared by the Chicago Fed for the period on or before August 28, "Hurricane Harvey created broad disruptions to economic activity along the Gulf Coast in the Dallas and Atlanta Districts, although it was too soon to gauge the full extent of the impact. Many firms and organizations in the affected areas closed due to flooding. A fifth of the oil and natural gas production in the Gulf of Mexico was offline, and many onshore producers in the Eagle Ford region temporarily stopped production. Harvey also affected fuel and petrochemical production, forcing fifteen refineries in the region to shut down temporarily and several others to operate at reduced capacity. Some areas experienced gasoline shortages, and supply was expected to remain tight in the Southeastern United States because of pipeline disruptions. Contacts in the Richmond District indicated that spot freight prices jumped after the storm, as freight was being redirected around the country. The Port of Charleston expected increased volumes in coming weeks as freight traffic is routed away from the Port of Houston". Hurricane Harvey would result in a slowdown in the third quarter growth. Headline inflation might be lifted in coming months but the rise would only be transitory.

Natural Gas

The Nymex natural gas contract plunged -5.86% last week. The EIA reported that gas storage rose +65 bcf to 3 220 bcf in the week ended September 1, from 3 155 in the previous week. Stocks were -212 bcf less than the same period last year and +15 bcf above the five-year average of 3 205 bcf. Separately, Baker Hughes reported that the number of gas rigs added +4 units to 187 in the week ended September 8. In terms of drilling types, directional rigs dropped -5 unit to 76, horizontal rigs slipped -1 unit to 793 and vertical rigs were up +7 units to 75. Together with the -3 unit fall in the number of oil rigs to 756 units, the total number of rigs increased +1 unit to 944 for the week.


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