- A sign of caution in financial markets on the US fiscal impasse…
- …but gold prices have only received limited support
- The main question now is whether gold is losing its safe haven appeal
- We expect gold prices to move lower
Are financial markets more risk averse?
The political uncertainty stemming from the fiscal impasse has resulted in a modest rise in the US sovereign CDS spread and has prompted investors to sell short-dated US Treasuries (1 month). This has resulted in higher US Treasury bill yields and has pushed the spread between US Libor and 1-month Treasury yield, the so-called TED spread, to very low levels. In fact, the spread has moved into negative territory. A negative spread reflects the market’s view that US sovereign risk exceeds that of related to US banks. In other words, this is an indication that investors are becoming concerned that the debt ceiling will not be raised on time, which could lead to a potential technical default. There are signs that investor selling of US government bills is slowly spreading to other maturities in the bond market as well. Equity market volatility has risen further, but the level of volatility has remained below the long-term average. In other words, there are no signs of panic yet. Meanwhile, currency markets have been paralysed by the US fiscal debate. The JPY and USD have received some support. What about gold?
Gold has received limited support so far
The performance of the ultimate safe-haven asset has been very disappointing. Since the US government shutdown, gold has moved up by only around 1%. We would not be surprised if investors still remember gold’s behaviour during the height of the liquidity crisis back in 2008. At that time, gold was aggressively sold off, because investors favoured cash and this may still be in the back of investors’ minds.
Gold losing its safe haven appeal?
The graph below should worry gold investors. Why? Because it clearly shows that gold is not supported by safe haven flows in the current environment. The rise in equity market volatility signals that the market is more cautious. However, gold’s behaviour does not manifest such nervousness. The neutral to decreasing sensitivity of gold to the equity market volatility highlights the higher likelihood that gold prices will not receive enough safe-haven support going forward. To be more specific, the safe-haven flows it may receive will unlikely be substantial enough to prevent gold prices from moving lower. If the US political deadlock is behind us, these safe-haven flows will be redirected into other assets and the bottom will most likely fall out from under gold prices.