Equities weaker, US yields lower, USD softer

The US Federal Reserve’s rejection of capital raising plans by several banks taken together with further confrontation between the US and Russia and a disappointing US durable goods orders report were sufficient to result in a sell off in equity markets, lower US yields and a weaker USD.

Gold failed to benefit in yet a further sign that its bull run has ended, with the metal honing in on its 200 day moving average at 1296.71. On the US data front headline February US durable goods orders beat expectations (2.2%) but core orders (-1.3%) were weaker than expected.

Although the lead for Asia is a weak one markets may still find some resilience due to expectations of policy stimulus from China. Similarly dovish talk from the European Central Bank will offer further support to market sentiment while undermining the EUR somewhat. On the data front today the main releases are US Q4 GDP revision (upward revision likely), and UK retail sales (rebound likely).

High degree of investor caution

Although risk aversion has declined from recently elevated levels there is still a high degree of caution from investors who are unwilling to take long term bets. The causes of market angst have remained unchanged over recent weeks namely Ukraine tensions, weaker growth in China and US data that has performed below expectations.

It is therefore unsurprising that in the wake of a weaker than forecast reading for Chinese manufacturing confidence yesterday and talk of more sanctions against Russia, European and US equity markets fell overnight and Asian equities have began the day on softer footing.

The Markit US manufacturing purchasing managers’ index (PMI) edged lower, but unlike the Chinese PMI, which remained below the 50 boom/bust level, the US reading was healthy at 55.5 in March. The Eurozone equivalent edged lower but continued to show that recovery was still in shape, with the March reading at 53.

The reverberations from Fed Chairman Yellen’s comments last week also inflicting some damage, with gold prices in particular succumbing to pressure and verging on a test of the 200 day moving average around 1296.83. A heavy slate of data today includes the German March IFO survey, UK CPI inflation, US March consumer confidence and February new home sales.

Market angst remains

The same themes continue to worry markets, with Ukraine and China cited on a daily basis as the main causes of market angst. Additionally there is a growing feeling that US equity indices may have topped out given the lack of additional impetus from earnings or economic data.

There is not much on the data front today that will change this dynamic for markets and what there is will be unimpressive, with US retail sales set to have remained soft in February (consensus 0.2%) as bad weather hit spending.

The main market movers overnight have been commodity prices which continue to weaken, with the CRB commodities index falling while the Baltic Dry Index also took a tumble. Gold continues to outshine hitting a high of $1375 per ounce, benefitting from the continued rise in risk aversion while in contrast copper prices dropped to a four year low around $6495 before rebounding slightly.

Ukraine fallout

So far most of the damage from the escalating crisis in the Ukraine and growing tensions between the West and Russia has been inflicted on Russian markets but global asset markets are also feeling increasing pain from the fallout. The most recent developments highlight that tensions have worsened further.

Equity markets in Europe were next in line for selling pressure, with sharp declines registered while US stock also dropped, but to a lesser degree. Commodity prices have also felt the shock, with European natural gas prices rising sharply and oil also higher. Gold has been a major beneficiary extending gains to around USD 1350.

US Treasury yields settled around 2.6% while the USD bounced as risk aversion spiked. My Risk Aversion Barometer rose over 3% while the VIX “fear gauge” jumped. Asian markets are likely to feel some pressure today although the impact is likely to be much less significant than elsewhere. Nonetheless, the lack of first tier data releases means that most attention will be focussed on developments in Ukraine over today’s trading session.

US dollar under pressure

US stocks have clawed back almost all their losses registered in the wake of the mini emerging markets crisis in January. The S&P 500 closed at 1838.63, up 0.48% on Friday. The rally in stocks is impressive considering the run of weaker than forecast US data releases over recent weeks although investors appear to be placing much of the blame on poor weather conditions. The gains in US stocks echoes the generalized improvement in risk appetite, with sentiment towards emerging markets also having stabilized.

The USD continues to be a casualty of the firmer risk tone, with a lack of upward momentum in US yields also not helping the currency (10 year US Treasury yield around 2.7428%). The USD index is now close to its lows for the year around 80.00, with the JPY and commodity currencies the biggest gainers so far this year among major currencies. In terms of emerging market currencies the Indonesian rupiah and Thai baht have been the best performers versus USD.

Despite the firmer tone to risk, gold prices have continued their ascent, closing above their 200 day moving average at the end of last week. As I wrote in Gold breaches its 200 day moving average, I don’t expect the rally in gold prices to be sustained. Some market consolidation is likely today with a lack of key data releases and a US holiday (President’s Day) keeping activity subdued.

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Gold breaches its 200 day moving average

AUDjobsGold prices have risen sharply since the beginning of the year, up over 8% year to date. Higher risk aversion, lower US yields and a weaker USD have boosted gold. Consequently gold prices are trading around their 200 day moving average level around 1303.70. This could prove significant, with a close above the 200 day moving average important to sustain any short term uptrend,

Encouraging signs for gold bulls
ETF investor demand appears to have stabilised over recent weeks while CTFC IMM demand appears to be picking up. This data suggests that Investors are tentatively moving back into gold. The poor performance of equity markets since the start of the year has indeed made gold look more attractive as an investment while lower yields mean that the opportunity cost of holding gold has lessened.

Chinese demand for gold increases sharply
Additionally gold demand from China has picked up strongly. China Gold Association data showed that Chinese demand for gold jumped 41% to 1,176 tonnes last year. Chinese demand likely overtook India’s last year. Oddly Chinese import and production data were even stronger, making it possible that China bolstered its reserves with gold last year.

Indian restrictions hit demand
India restricts demand for gold via import restrictions. However, there is a lot of pressure domestically to remove these restrictions and a review is scheduled to take place at the end of the fiscal year at end March 2014. If these restrictions are removed or at the least weakened, Indian gold imports could increase sharply but it seems unlikely that imports will rise as strongly as previous years.

Moreover, the Indian government will want to avoid an adverse impact on India’s current account deficit, suggesting that a complete removal of gold import restrictions is unlikely. However, in the meantime the restrictions are having a major impact on Indian gold demand which dropped sharply last year.

Gold rally to fade
Risk appetite has already improved sharply over February and while I continue to expect bouts of volatility in the weeks and months ahead I do not expect to see sustained periods of elevated risk aversion. Therefore any boost to gold from rising risk aversion is set to prove temporary in the months ahead.

Secondly global inflation pressures remain well contained. Inflation for the major economies is likely to remain benign. Only in Japan is inflation expected to pick up but this is an aim of policy and is not expected to result in a bout of gold buying to hedge against such inflation risks. Therefore, gold demand as an inflation hedge will not take place.

Two major drivers of the gold price are US bond yields and the US dollar. Both are highly correlated with gold price gyrations, with gold falling as US yields and the USD rise and vice-versa. Both yields and the USD are set to rise over the coming months. Consequently any short term gold price gains are unlikely to hold, with the metal set to resume its decline.

Awaiting Yellen

There was very little activity of note overnight, with markets taking on the appearance of grounding to a halt ahead of the first semi-annual testimony to Congress by new Fed Chairman Yellen later tonight. A Japanese holiday today will act as another dampener on activity.

Weaker data and/or emerging market tensions are highly unlikely to deter Yellen and the Fed from maintaining a tapering path but of interest to markets will be any indication that the unemployment rate is to be deemphasized given its misleading fall over recent months. With little else of note on tap until the release of US retail sales and Eurozone Q4 2013 GDP later in the week Yellen’s speech will set the tone for markets over coming days.

The biggest market movers over recent days have been the VIX index, natural gas and gold prices. The VIX has fallen sharply reflecting a major turnaround in risk appetite from an elevated level, which has been corroborated by our risk barometer moving back into risk ‘neutral’ territory from risk ‘hating’.

Nonetheless, although emerging market fears have calmed down the path ahead is still likely to be a volatile one. Natural gas prices have also dropped reflecting expectations of milder weather ahead in the US. In contrast gold prices have rallied further extending gains this year to around 6%. Lower US yields and a weaker USD have helped to buoy gold prices over recent days while news of record gold demand and supply from China has also helped.

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