To observers of financial markets it must seem odd that they often behave exactly the opposite to what is expected. Explaining it is also a strange thing too.
Essentially when the US Federal Reserve jawbones a potential move such as a rate hike (for the best part of a year), investor positioning is congruent with the expected outcome – that is to say dollar / equities up an by extension, gold down.
But what happens when they are too successful in leading the markets expectations and the market positioning is too extreme for the expected move. Well you have a heap of investors who are short gold and long the dollar / equities who don’t get the win they expected… that is to say the move is over-priced into the news. As such, those investors – be they speculators in the futures markets or physical buyers who have forestalled their purchases for a hoped for price correction … are vulnerable.
In this environment a little counter-intuitive buying of gold and selling dollar / equities is usually sufficient to frighten them into covering their position. In short, markets end up moving exactly the opposite way to how classic economics would tell us. And the move feeds on itself because of the extreme positioning.
Evidence to support this view is gold’s move over the last few rates increases – the 25 bps increase in December 2015 saw a subsequent 18% rise in gold over the following 3 months. Meanwhile the December 2016 rate rise saw an 8% increase over the next 3 months. Yesterdays rate rise has seen a 2.4% rise in gold so far … and appears to be petering out. What this indicates is that the wonderful ruse by institutions who exploit predictable investor behaviour seems to be running its course.
So where do we go from here – well having been burned by behaving logically, presumably those investors who keep finding themselves “long and wrong” in dollar/equities and “caught short” in gold will be more perspicacious – a posh way of saying more wise and cynical. Ultimately we could just end up not listening at all.
Sharps Pixley, London
…related, published prior to rate hike: