You know markets are really getting bad when gold rallies

China Photos/Getty Images

Last night gold traded at $1,200 an ounce.

That’s up $155 from the December low for a gain of close to 15%. It’s also a sign of just how bad things are getting in markets.

We know that because traders and investors have ignored gold for years. Through all the market ructions, turmoil and fear, gold’s fall has continued unabated.

Since making a high above $1900 back in September 2011, gold’s inexorable decline continued. At least until the last 8 weeks when it hit a $1,045 in early December. That meant it had lost 45% from the highs and calls from prominent investment banks were for prices to head under $1,000 an ounce.

Gold’s continued decline was regardless of changes in supply and demand of new gold production and central bank actions which suggested prices should find support. Likewise, gold’s fall continued regardless of the big volatility spikes we saw in markets in 2015.

Gold’s safe haven status was questioned. If it can’t rally even during the Greek crisis, China devaluation or market rout of August and September 2015, then when can it rally, traders wondered.

But something has changed in 2016.

Gold – Daily (Reuters Eikon)

After hitting $1,045 in early December, gold stopped falling. From a trading perspective that’s unremarkable – gold was, after all, sitting close to the bottom of the downtrend it has been in for the last couple of years. That meant it was also close to a natural place for traders to start to buy for a bounce.

Yet even though gold finding support was fairly predictable, the rally of 15% since the lows and 10% in the past month tells us traders and investors are getting more, not less worried, about the outlook for the year ahead.

Bank of America Merrill Lynch fund flow data released over the weekend shows that money is running from risk and into safe haven or lower volatility assets. BAML highlighted that:

Risk-off weekly flows: large ($9.9bn) Equity redemptions; more ($2.4bn) inflows to US Treasury funds; and strong ($0.7bn) inflows to Precious Metal funds.

Fixed income says “Deflation”: 5th consecutive week of robust inflows to govt/tsy bond funds; 20th straight week of muni bond inflows; 14th straight weeks of bank loan fund outflows; EM debt outflows in 25 of past 28 weeks.
Equity sector rotation is defensive: utilities see largest inflows in 13 months ($0.9bn); healthcare/biotech record largest outflows in 5 months ($1.2bn) (Chart 1); note however that financial sector funds saw first inflows in 8 weeks.
Gold inflows indicate USD consensus reversing: 4th straight week of inflows ($2.3bn in total) to gold funds, as investors’ US$ unwind (encouraged greatly in past week by
ECB/BoJ/Fed) shifts from discounting slowdown to discounting policy response.

Clearly BAML is suggesting the gold bet is also a bet that the US dollar will fall. That much is certainly true in the short run. But it’s also a fair bet that gold’s rally is in part fuelled by investors’ desire for a safe haven in a world where almost everything except government bonds is under downward price pressure.

There is also another possibility.

Gold offers Chinese investors and traders the best possible hedge against what many believe will be an ultimate devaluation of 25% or more in the Chinese currency, the yuan. China’s central bank might be instituting rules, and spending some of its vast pile of foreign exchange reserves to slow the fall of the yuan. But locals can happily buy gold in the knowledge that the value will rise in yuan terms when the devaluation eventually comes.

Is gold’s rally sustainable? No-one knows. But the sharp rise in price speaks volumes for how spooked traders and markets are getting as 2016 continues.

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