Gold’s Role in Turbulent Times
What you'll read in this issue:
TOP STORY
Understanding Gold's Complex Nature
Gold’s recent price rise has drawn attention to its status as a steadfast protector of wealth. However, its price dynamics reveal a more nuanced story than simply acting as an inflation hedge.
Background: When inflation rises, the purchasing power of a currency falls, which means the value of certain assets rises. This leads investors to seek assets that either maintain value or appreciate, writes Bob Iaccino. Gold has historically been one of these assets because it is scarce, durable and has intrinsic value.
Real Interest Rates: When the Federal Reserve chooses not to hike interest rates in response to rising inflation, real interest rates – the nominal rates adjusted for inflation – tend to fall. Lower real interest rates reduce the opportunity cost of holding gold, which does not offer any yield. Consequently, gold becomes more attractive to investors, not just as an inflation hedge but as an appreciating asset in an environment where traditional income-generating investments yield less in real terms.
Why It Matters: The global nature of gold markets means that while the Federal Reserve's policies are influential, they are not the sole determinants of gold prices. Central bank policies worldwide, global economic growth rates and even technological advances in gold mining and recycling can significantly shape gold's supply and demand dynamics.
FEATURED TOPIC
The Halving’s Impact on Bitcoin Prices
Bitcoin’s halving is scheduled to occur roughly every four years, or every 210,000 blocks, until the entire 21 million bitcoin supply is mined. The fourth halving occurred recently on April 19.
Background: Halving was written into bitcoin’s code to ensure scarcity and to protect from inflation, and the recent halving reduced miners’ rewards from 6.25 to 3.125 bitcoins per block. Historically, each halving event has been accompanied by a significant surge in bitcoin price in the months preceding and following the event.
Why It Matters: This halving was marked by novel dynamics that could reshape prevailing narratives around bitcoin economics, such as the reduction of bitcoin supply subsidy, the emergence of a liquid investment ecosystem via CME Group futures and options, the advent of spot bitcoin ETFs and the introduction of Ordinals.
Quotable: “There is no guarantee that bitcoin will rally in response to its upcoming halving,” said CME Group Chief Economist Erik Norland prior to the halving, noting that bitcoin has been losing upward momentum as growth in its user network has slowed. “The recent interest in bitcoin ETFs has pushed transaction volumes upwards which might, along with the upcoming halving, give bitcoin yet another lift.”
Read more about the market’s response to past halvings, dynamics that made this halving different and the role of scarcity.
INSIGHTS
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Using Equity Options in an Election Year
2024 has the potential to be a volatile year in financial assets due to the upcoming election. The outcome of the election could have implications on tax policy, government spending, tariffs and immigration – all of which could affect equity markets.
Past Election Years: Since 1928, the average stock market return in a presidential election year is 7.5%, slightly lower than the overall average of 8.5%. The theory was that elections represented uncertainty, and equities don’t love uncertainty. In recent years, something seems to have changed.
Options Growth: Since the last presidential election year, options have grown as a tool for risk mitigation and speculation. Options volume for CME Group equity indexes has risen from approximately 30 million contracts in the first quarter of 2015 to almost 100 million in the fourth quarter of 2023.
Preparing for the Unexpected: With options, a trader can express a trade idea based on the expected volatility of an asset that may be directionally agnostic. If a trader believed an asset may have an explosive move in either direction, as a result of a binary headline event like an election, they could use options to protect their positions around the event.
Price Volatility in the Bond Market
Bond market volatility over the last three years has been historic. The uncertainty of inflation, the labor market and the global economy will likely keep volatility at the forefront of the treasury market.
Background: As rates fall, bond prices rise because it is worth more to hold the rights to bond repayments based on their higher rates. At the beginning of the pandemic, bond prices soared as traders and investors were searching for yield. Not only did prices rise sharply but so did treasury volatility.
Inflation and Interest Rates: As the shock of the pandemic eased and a global economic recovery ensued, inflation started to rise, which is a negative for the bond market. Central banks around the world raised rates at a feverish pace, pushing down bond prices, as existing bonds with low rates are less attractive than new bonds. In October 2023, bond prices started rising again as inflation fell more than expected while the outlook for rate cuts seemed like a reality.
Uncertainty Continues: The 10-year U.S. Treasury Note is one of the most closely watched benchmarks in the world. The CME Group Volatility Index (CVOL) skew in the 10-year over the last six months is representative of the uncertainty of the bond markets and where interest rates may be headed.
Naphtha Futures Trading Rebounds Sharply
Total trading volumes of naphtha, which competes with propane as petrochemical feedstock, surged by 40% across several markets in 2023 after commercial firms turned to the futures markets to manage risk amidst heightened uncertainty.
China Drives Demand: Imports into Asia were under a cloud due in part to weak economic growth in top consumer China. Although there’s an overall slowing in the rate of demand, the Asian petrochemical sector is likely to continue drawing higher volumes of naphtha:
European Imports Decline: European naphtha prices have fallen sharply compared to those in Asia, and this has led to higher volumes of European naphtha cargoes shipped eastward. CME Group data shows that the price of Asia naphtha was trading at over a $25 per metric ton premium to the European market, the highest level in around 15 months.
Why It Matters: Asian naphtha demand is expected to rise, and in some cases exceed, total production volumes. This implies that the supply/demand situation could tighten in the months ahead and may prompt further hedging of the underlying commodity price volatility.
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