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WHAT COULD THE NEW ECB STIMULUS PACKAGE MEAN FOR GOLD?

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Colin Cieszynski

A MarketTrends Special Report by Colin Cieszynski, Market Analyst, CMC Markets

Following the ECB revealing its plans for the year, Colin Cieszynski assesses how this could affect the performance of gold and the expectations for its future.

Within the report Colin discusses:

  • ECB’s latest plans for the year including cuts to lending rates and actions by the central bank to manage money supply
  • How in recent years the pricing of gold has been affected by its relationship with the USD
  • How we have seen a shift in relationships between gold and the USD to the EUR
  • The expectations for gold in the future and how ECB’s policy could impact this

On Thursday June 5th, after over 18 months of steadily removing emergency liquidity from its financial system, the ECB made a sharp U-turn announcing a series of stimulus plans through the end of the year. These included a cut in lending rates to almost zero and forcing banks to pay to part their cash at the central bank; the weekly bond sterilization program that had tied up a significant amount of its money supply, €400 billion in new targeted LTRO loans to come in September and December 2014. In addition, the ECB indicated that it is looking into buying asset backed securities and possible QE.

This major turn in monetary policy exceeded street expectations and sparked an immediate rally in gold which may have signalled a major turning point for the yellow metal after nearly three years of declines.

Gold as a store of value

Colin Cieszynski

Colin Cieszynski

For centuries, gold has been seen as defensive currency, a store of value in turbulent times and a hedge against inflation in paper money. In recent decades, pricing in gold (the premier hard asset) has been driven by its relationship with USD (the world’s premier leading paper currency). Since the early 1970s, gold has rallied during times of political or economic uncertainty or during times of inflation and weakened when paper money rebounded.

An example of this relationship has been in the resurgence of gold since the turn of the century as USD retreated. Most specifically the first two QE programs ignited major rallies in gold as big increases in the supply of US Dollars depressed the value of the paper currency.

Table One: Performance of Gold during US QE programs

QE1 Nov 2008-March 2010 36.3%
QE2 Nov 2010-June 2011 8.3%
QE3 Sept 2012 – present (May 2014 to date) 29.5%

Source: CMC Markets

Relative to the first two programs, gold performance since the start of QE3 has been truly dismal. It also indicates that gold’s relationship with paper currencies has changed dramatically in recent years.

Trading in Gold relative to the Euro

What has become increasingly clear in the last few years is that since the start of this decade, gold’s primary relationship in trading has changed from USD to EUR. The European sovereign debt crisis sparked major new flows of capital from Europe into gold that has changed its main trading drivers.

The chart below shows that the advances of gold generally tracked expansion of the money supply in the US and Europe from the early 2000s through to the summer of 2012. At that point, the ECB and the Fed diverged in their approach to money supply. The ECB ran a stealth taper where it shrank its balance sheet by €1 trillion over 18 months as banks paid back their borrowings under the first LTRO program. At the same time, the Fed expanded its balance sheet dramatically through the QE3 program.

Over the same time period, instead of rallying as it did during the US QE1 and QE2, gold sold off, indicating that it had started to take its cue more from the shrinking money supply and reductions in political and financial risks from Europe, than from the Fed.

Chart One: Relationship between central bank assets and currency prices January 2000-present

WHAT COULD THE NEW ECB STIMULUS PACKAGE MEAN FOR GOLD? 5

Source: CMC Markets, Bloomberg L.P.

What could the ECB policy change mean for gold?

Between September of 2012 and March of 2014, the ECB reduced its asset base by about €1 trillion. The sterilization and targeted LTRO moves announced in early June may restore substantial part of this.

The end of weekly sterilization frees up €165 billion immediately, with two tranches of targeted LTROs slated to add another €400 billion by the end of the year. This means that we could see the ECB restore €565 billion of the €1 trillionish it took away or about a 56% restoration. This does not count any additional funds from new ABS purchase or other QE type programs.

If gold continues to follow its recent trend of tracking the size of the ECB balance sheet, it could potentially stage a 56% retracement of its losses over the last few years in the coming months. Considering that 50%-62% Fibonacci retracements are common in markets around the world, a rebound of this magnitude does not appear to be out of the question.

Chart Two: Gold price in USD 2011-present

The chart below shows that following its peak in late 2011, gold sold off dramatically over the next two years. In the last year, however, gold has been consolidating and base building in a $1,180 to $1,400 trading channel.

Near the end of 2013, gold completed a double bottom near $1,185 which coincided with a positive RSI divergence to suggest that the previous downtrend is coming to an end.

At this point it would take a break through $1,400 to signal the start of a new recovery trend, but if gold does track the re-expansion of the ECB’s balance sheet, a 50% to 62% retracement of the previous downtrend suggests the $1,555 to $1.640 zone could potentially be probed over time.

WHAT COULD THE NEW ECB STIMULUS PACKAGE MEAN FOR GOLD? 6Source: CMC Markets

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Barclays announces new trade finance platform for corporate clients

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Barclays announces new trade finance platform for corporate clients 7

Barclays Corporate Banking has today announced that it is working with CGI to implement the CGI Trade360 platform. This new platform will provide an industry leading end-to-end global trade finance solution for Barclays clients in the UK and around the world.

With the CGI Trade360 platform, Barclays will provide clients with greater connectivity and visibility into their supply chains, allowing them to optimise working capital efficiency, funding and risk mitigation. By utilising cloud based functionality for corporate banking clients, Barclays will also be able to offer a leading client user experience through easy access and real-time integration to essential information, combined with the latest trade solutions as the industry-wide shift to digitisation continues to accelerate.

This move underpins Barclays commitment to supporting the trade and working capital needs of their clients and reinforces a commitment to innovation that has been central to the bank for more than 300 years.

James Binns, Global Head of Trade & Working Capital at Barclays, said: “We are delighted to announce our move to the CGI Trade360 platform and to have started the implementation process. We have a longstanding partnership with CGI, and the CGI Trade360 platform will mean we can continue delivering the best possible trade solutions and service to our clients for many years to come.”

Neil Sadler, Senior Vice President, UK Financial Services, at CGI, said: “Having worked closely with Barclays for the last 30 years, we knew we were in an excellent position to enhance their systems. Not only do we have a history with them and understand how they work, but part of the CGI Trade360 solution includes a proof of concept phase, which is essentially seven weeks of meetings and workshops with employees across the globe to guarantee the product’s efficiency and answer all queries. We’re delighted that Barclays chose to continue working with us and look forward to supporting them over the coming years.”

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What’s the current deal with commodities trading?

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What’s the current deal with commodities trading? 8

By Sylvain Thieullent, CEO of Horizon Software

The London Metal Exchange (LME) trading ring has been the noisy home of metals traders buying and selling for over a hundred years. It’s the world’s oldest and largest metals market and is home to the last open outcry trading floor. Recently however, the age-old trading ring, though has been closed during the pandemic and, just a few weeks ago, the LME announced that it will remain so for another six months and that it is taking steps to improve its electronic trading. This news fits in with a growing narrative in commodities about a shift to electronic trading that has been bubbling away under the surface.

Something certainly is stirring in commodities. The crisis has affected different raw materials differently: a weakening dollar and rising inflation risks bode well for some commodities with precious metals being very attractive, as seen by gold reaching all-time highs. Oil on the other hand has had a tough year and experienced record lows from the Saudi-Russia pricing war. It has been a turbulent year, and now prices look set to soar. While a recent analyst report from Goldman Sachs predicts a bullish market in commodities for the year ahead, with the firm forecasting that it’s commodities index will surge 28%, led by energy (43%) and precious metals (18%).

Increasingly, therefore, it seems that 2020 is turning out to be a watershed moment for commodities, and it’s likely that the years ahead will bring about significant transformation. And whilst this evolution might have been forced in part by coronavirus, these changes have been building up for some time. Commodities are one of the last assets to embrace electronic trading; FX was the first to take the plunge in the 90s, and since then equities and bonds have integrated technology into their infrastructure, which has steadily become more advanced.

The slow uptake in commodities can be explained by several truths: the volumes are smaller and there is less liquidity, and the instruments are generally less exotic, essentially meaning it has not been essential for them to develop such technology – at least not until now. This means that, for the most part, the technology in commodities trading is a bit outdated. But that is changing. Commodities trading is on the cusp of taking steps towards the levels of sophistication in trading as we see in other asset classes, with automated and algo trading becoming ever prominent.

Yet, as commodities trading institutions are upgrading their systems, they will be beginning to discover the extent of the job at hand. It’s no easy task to upgrade how an entire trading community operates so there’s lots to be done across these massive organisations. It requires a massive technology overhaul, and exchanges and trading firms alike must be cautious in the way they proceed, carefully establishing a holistic, step-by-step implementation strategy, preferably with an agile, V-model approach.

The workflow needs to be upgraded at every stage to ensure a smooth end-to-end trading experience. So, in replacement of the infamous ring, these players will be looking to transform key elements of their trading infrastructure, including re-engineering of matching engines and improving communications with clearing houses.

However, these changes extend beyond technology. For commodities players to make a success of the transformation in their community, exchanges need to have highly skilled technology and change the very culture of trading. All of which is currently being done against a backdrop of lockdown, which makes things much more difficult and can slow down implementation.

What is clear is that coronavirus has definitely acted as a catalyst for a reformation in commodities. It is a foreshadowing of what lies ahead for commodities trading infrastructure because, a few years down the line, commodities trading could well be very different to how it is now, and the trading ring consigned to history.

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Afreximbank’s African Commodity Index declines moderately in Q3-2020

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Afreximbank’s African Commodity Index declines moderately in Q3-2020 9

African Export-Import Bank (Afreximbank) has released the Afreximbank African Commodity Index (AACI) for Q3-2020. The AACI is a trade-weighted index designed to track the price performance of 13 different commodities of interest to Africa and the Bank on a quarterly basis. In its Q3-2020 reading, the composite index fell marginally by 1% quarter-on-quarter (q/q), mainly on account of a pull-back in the energy sub-index. In comparison, the agricultural commodities sub-index rose to become the top performer in the quarter, outstripping gains in base and precious metals.

The recurrence of adverse commodity terms of trade shocks has been the bane of African economies, and in tracking the movements in commodity prices the AACI highlights areas requiring pre-emptive measures by the Bank, its key stakeholders and policymakers in its member countries, as well as global institutions interested in the African market, to effectively mitigate risks associated with commodity price volatility.

An overview of the AACI for Q3-2020 indicates that on a quarterly basis

  • The energy sub-index fell by 8% due largely to a sharp drop in oil prices as Chinese demand waned and Saudi Arabia cut its pricing;
  • The agricultural commodities sub-index rose 13% due in part to suboptimal weather conditions in major producing countries. But within that index
    • Sugar prices gained on expectations of firm import demand from China and fears that Thailand’s crop could shrink in 2021 following a drought;
    • Cocoa futures enjoyed a pre-election premium in Ghana and Côte d’Ivoire, despite the looming risk of bumper harvests in the 2020/21 season and the decline in the price of cocoa butter;
    • Cotton rose to its highest level since February 2020 due to the threat of storm Sally on the US cotton harvest, coupled with poor field conditions in the US;
    • Coffee rose 10% as La Nina weather conditions in Vietnam, the world’s largest producer of Robusta coffee, raised the possibility of a shortage in exports.
  • Base metals sub-index rose 9% due to several factors including ongoing supply concerns for copper in Chile and Peru and strong demand in China, especially as the State Grid boosted spending to improve the power network;
  • Precious metals sub-index, the best performer year-to-date, rose 7% in the quarter as the demand for haven bullion continued in the face of persistent economic challenges triggered by COVID-19 and heightening geopolitical tensions. In addition, Gold enjoyed record inflows into gold-backed exchange traded funds (ETFs) which offset major weaknesses in jewellery demand.

Regarding the outlook for commodity prices, the AACI highlights the generally conservative market sentiment with consensus forecasts predicting prices to stay within a tight range in the near term with the exception of Crude oil, Coffee, Crude Palm Oil, Cobalt and Sugar.

Dr Hippolyte Fofack, Chief Economist at Afreximbank, said:

“Commodity prices in Q3-2020 have largely been impacted by COVID-19. The pandemic has exposed global demand shifts that have seen the oil industry incur backlogs and agricultural commodity prices dwindle in the first half of the year. The outlook for 2021 is positive however conservative the markets still are. We hope to see an increase in global demand within Q1 and Q2 – 2021 buoyed by the relaxation of most COVID-19 disruptions and restrictions.’’

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