The most recent moves in gold have been unusual to say the least. When US equities originally began its steep decline during the week of February 24, gold traded lower that week. Gold prices opened at $1653 and by the end of the week gold closed at $1566. Although equities (risk on asset class) and gold (safe haven asset class) typically have a inverse correlation meaning they do not run in tandem very often.
However, at the beginning of a steep decline in global equities the fear factor prompts many investors to simply liquidate all of their investments into something like treasury bonds that offer very little interest, but have a guaranteed safety factor in that you will not lose any money. The other reason market participants liquidate gold during mass selloffs in equities is to raise capital to cover margin calls if they’re planning on holding onto their current position. We have seen this situation unfold on multiple occasions.
We have seen that scenario play out on multiple occasions when equities come under harsh pressure and market participants liquidate many investments including gold Typically, if US equities continue to drop for an extended period of time the mass liquidation of gold holdings ends, as traders move their assets from risk-on to safe haven. That is exactly what we saw last week.
The interesting part is this week equities continue to trade under pressure, well into an official corrective stage with the Dow losing 13% during the first week of the selloff. According to CNBC the Dow dropped another 1400 points today and is certainly now deeply in bearish territory with a market Decline of approximately 20%.
Viewing the list of stock market meltdowns in the past this last occurrence of a deep correction occurred during the financial crisis of 2008. During the initial selloff like we saw during the week of February 24 both gold and equities sold off harshly in tandem.
Simply put, it is very unusual for equities and gold to both trade dramatically lower for extended periods of time. As reported by MarketWatch today, analysts at Zaner metals wrote a note which said, “We were less than impressed with gold’s move [higher] on Monday when the bottom fell out of the stock market, as gold barely poked above the $1,700 level and failed to meet upside technical targets,”. However, one of the most interesting parts of their analysis was one possible explanation as to why this is occurring now.
“Perhaps central banks were selling gold to fund their government’s efforts to deal with the coronavirus.”
This would explain why gold has traded to its lowest finish in over a week as central banks around the world may have had to liquidate gold reserves in order to fund a stimulus plan or raise capital to get them through the epidemic that may bring GDP to a halt.
Gold traded to a low today of $1633, currently gold is trading at $1641.30 at the open of trading in Australia.
What is clear is that the current epidemic in China concerning the coronavirus is moving closer towards a pandemic week by week, and without a vaccine which could take up to a year to produce, and the long period that individuals are able to transmit the disease and at the same time have no symptoms. For that reason that it is almost certain that there will be many more cases globally. If that is how this crisis unfolds, we can expect the global economy to continue to contract and thereby put further downside pressure on global equities.
Wishing you as always good trading,