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Gold to Follow S&P 500 Lower Amid Broad-Based Risk Aversion

Gold to Follow S&P 500 Lower Amid Broad-Based Risk Aversion

2011-05-22 02:51:00
Ilya Spivak, Sr. Currency Strategist
Share:
Gold_to_Follow_SP_500_Lower_Amid_Broad-Based_Risk_Aversion_body_Picture_5.png, Gold to Follow S&P 500 Lower Amid Broad-Based Risk Aversion

Fundamental Forecast for Gold: Bearish

Gold prices rebounded last week, adding 1.2 percent having suffered heavy losses over the preceding 10 days. Tellingly, the yellow metal has carved out an increasingly strong link with the S&P 500 – the go-to proxy for tracking overall risk appetite – with correlations between the two now near the strongest levels in six months. Indeed, gold faced aggressive selling pressure in the first two weeks of May even as shares collapsed and the US Dollar rebounded, tying it up firmly into risk on/off bipolar trading dynamics it had largely avoided previously.

Through much of the 2008 financial crisis, the subsequent recession and its aftermath, gold had proven attractive to bulls and bears alike. At times of optimism, it was sought after as a store of value to hedge against what many expected to be a period of runaway inflation. At times of pessimism, investors flocked to the metal expecting recession to begin anew as government stimulus ran dry while the private sector remained too weak to pick up the slack, erasing gains in paper assets and once again fueling demand for a tangible store of value.

The metal’s apparent move to one side of the sentiment spectrum over recent weeks as little to do with risk appetite in general, but rather with a looming paradigm shift across financial markets: the looming expiration of quantitative easing (QE). As of June 9th, Ben Bernanke and company will take a step back from bond markets, telling investors, “From this point forward, you are on your own, and if yields rise then so be it.” Needless to say, the size of the US budget deficit and the amount of new bond issuance that it implies – not to mention the recent S&P downgrade of the US credit outlook – suggests borrowing costs will move higher as bond prices decline.

Presented with such stark reality at the late-April FOMC policy meeting, investors began to book profits on their Dollar-funded positions, sending all of the assets that had benefited from access to cheap capital through QE – with gold (as well as other commodities), stocks and high-yielding currencies among them – broadly lower while the greenback enjoyed a robust recovery. Needless to say, the markets do not move in straight lines, with last week producing a corrective retracement as the emerging downtrend ran into short-term bargain hunters. Looking ahead however, with only three weeks to go before the second round of QE is complete, the urgency behind the unwinding process seems sure to increase, pushing gold lower in the process.

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