Remember back to late February.
Covid-19 was spreading rapidly across the globe and pretty much everywhere was fast heading into lockdown.
Everyone was panicking about 1) the health of themselves and of the ones they love and 2) about the impact that lockdowns would have on the global economy.
The panic got so intense by early March that investors, desperate for rapidly disappearing liquidity, started to sell anything and everything in exchange for USD. Traditional havens such as bonds, JPY and gold were all slammed and USD bid amid what analysts are now calling a dollar liquidity crunch.
This dollar liquidity crunch only subsided when the global central banks, led by the US Federal Reserve, began to flood the market with liquidity via huge QE programmes, repo operations and USD swap lines (where the Fed would offer other major central banks access to cheap USD funding to pass on to their own financial markets).
Gold, which (as I always say) loves QE, recovered aggressively as the USD funding squeeze eased, rallying from mid-March lows of under $1500 to above the $1700 level by mid-April.
Since then, gold has remained supported just above $1700, caught between the conflicting fundamental forces of improving risk appetite over the past few weeks (typically a gold negative) and a softening USD amid aggressive Fed balance sheet expansion (USD weakness is typically gold positive).
However, for the first time since March, the Fed balance sheets actually shrunk this week, amid a lack of take up of the Fed’s USD swap lines by foreign global central banks.
That essentially means that the Fed inadvertently removed USD liquidity from the market this week – no wonder USD has been fairly well supported!
Moreover, in what seems to have been a move coordinated with the Fed, the ECB, BoE, SNB and BoJ will all now reduce the amount of USD offered to local banks – previously they were doing these offerings every day, now they will happen only 2-3 times per week.
Markets have not really reacted to such headlines today. But, in my view, there is a risk that we are at a turning point which could have a BIG impact on gold.
With foreign central bank’s making less use of Fed USD swap lines, and the subsequent shrinking of the Fed’s balance sheet that is likely to continue, USD liquidity conditions are likely to start to tighten again.
This ought to offer some support to USD, but may weigh much more heavily on gold.
As noted above, USD weakness/better USD liquidity conditions has been a key factor keeping a floor under gold prices in the past few weeks while risk appetite, particularly in the stock and crude oil markets, has picked up.
With this floor at risk of being removed, gold might suffer – especially if global equity markets continue to press higher amid the narrative of better economic data/continued post-Covid-19 economic reopening.
If gold was to break through the May/June lows of $1670, the door would be open to a move to $1600 or even lower.
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