(Kitco News) – Gold’s gains last week were driven by the return of the ‘mystery buyer’ in Asia, and the moves were magnified by the algorithmic traders who have become the dominant force in commodities markets, according to TD Securities’ senior commodity strategist Daniel Ghali.
In a Jan. 27 interview, Ghali said that gold had a unique setup into the beginning of this year, but the environment had shifted once again.
“We headed into U.S. elections with a completely different setup for flows in gold markets,” he said. “We had, at the time, macro funds and discretionary traders who showed some signs that their positions were extreme – what we're talking about when we say extreme is the highest levels since the Brexit referendum or the stealth QE narrative in 2019, or even more so than during the depths of the covid crisis – so there were really a lot of signs out there of some euphoria within this cohort of gold investors.”
But the drawdown in precious metals markets over the weeks that followed the U.S. election forced this community to liquidate a large portion of their extreme position sizes, Ghali said.
“Really what we are left with here is a setup where a continued weakening in the U.S. dollar and U.S. rates is going to lead this cohort to continue to buy,” he said. “But conversely, the opposite scenario, in which the U.S. dollar continues to rise, has now reached levels that are sufficiently strong to catalyze what we've called the return of the ‘mystery buyer,’ this community of buyers out of Asia, which really were one of the big reasons why gold prices performed so well last year.”
Ghali clarified that the ‘mystery buyer’ in gold markets isn’t a single individual or entity, but rather a small and influential group of buyers with deep pockets who are responding to the weakness in Asian currencies.
“When we talk about the mystery buyer, really what we're referring to is a group of several different buyers,” he said. “This could be reflected in the rise in retail buying activity in gold last year out of China. It could also be reflected in Asian institutional buying of gold, which was very significant over the course of last year, and ultimately what we think is the return of central bank buying activity in a bigger way as a result of Asian currency depreciation pressures.”
Ghali was then asked about the ‘algos,’ or algorithmic trading platforms, which he suggested last week were likely driving a significant amount of gold’s price appreciation last week.
“What's interesting, and a lot of people aren't aware of this, is that across commodity markets today and including in gold, trend-following algorithms are now the dominant speculative cohort in commodities markets,” he said. “The last bear market in commodities was almost an extinction-level event for the traditional commodity funds out there, and algorithmic traders are really the ones that benefited from that and grew to be this dominant force. Over the course of the last week, we think commodity trading advisors, which is one term to talk about these trend-following algorithms, were a significant contributor to recent gains.”
“But by the way, this session alone, gold prices are under pressure, and part of that story is quant fund deleveraging as a result of the risk off tone in markets, and that catalyzed subsequent CTA selling activity as well,” he added. “So you have to be very nimble with respect to how these algo flows are going to play out. But over the course of last week, that was a contributor, and we think this is going to continue to contribute to buying activity in gold.”
Ghali said that this algorithmic trading cohort became the dominant force in commodities markets following the global financial crisis of 2007-2008.
“The depth of the covid pandemic was the end of the last commodity bear market, and really the beginning of the new commodity bull market,” he said. “The traditional commodity funds were devastated by that bear market, and the implication is that one of the beneficiaries of that is that CTAs became the dominant speculative cohort in commodities markets today. There are some nuances there, but by and large, momentum or trend following is the dominant return engine within this community, so what we're talking about is the types of funds that will look at recent price action and infer future price action from there.”
Ghali was also asked about the Federal Reserve's rate path, and whether the expectation of fewer and shallower interest rate cuts would means a worse outlook for gold prices.
“Typically it is,” he said. “The traditional correlation is a strong U.S. dollar is bad for gold, higher U.S. rates are bad for gold. But the extent to which the U.S. dollar has strengthened as a result of the Fed's pivot is significant enough that Asian currency markets have depreciated sufficiently to bring back this mysterious buying activity. Most of the strength in the Asian physical markets over the last year was really the result of currency depreciation hedges, which we think in the early [part of this] year started to show signs of coming back on.”
Ghali has been among the earliest market experts to signal shifts in the precious metals market over the last few months. In late November, he sounded the alarm over the unwinding of massive long gold positions.
“We now expect imminent buying exhaustion,” Ghali warned. “From a macro perspective, the Fed's discounted path is no longer likely to lead to an 'overly easy' policy stance, suggesting that macro fund interest is unlikely to return towards extreme levels.”
“Price action has finally been sufficiently strong to force CTAs back into an effective 'max long' position size, suggesting that every single trend signal on our radar is already pointing long, which will in turn cap subsequent algo buying activity,” Ghali noted. “And, the TINA trade is still reversing in China, suggesting that Asian demand won't save the day.”
“The set-up for flows in silver is notably superior,” he said.
Then, on Jan. 7, Ghali warned investors of an unprecedented situation unfolding in the silver market.
“It's hard to see it in flat prices, but over the last month there's been a huge disruption in precious metals markets where the threat of universal tariffs on metals is leading traders around the world to bring metal in from London and other global venues into the U.S., only to hedge against the risk that tariffs will be implemented on precious metals,” he said. “Historically they haven't – precious metals have been considered money in effect – but if they were to be subject to tariffs, then traders holding short positions against metal that they actually hold somewhere else in the world would be subject to substantial losses.”
“In order to hedge against that risk, they're bringing metal into the U.S.”
Gold prices are seeing renewed strength on Tuesday, with spot gold gaining steadily as the North American session enters its midpoint and trading near session highs.
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Spot gold last traded at $2,756.27 per ounce for a gain of 0.57% on the session.