Steady Gold Amid Choppy Recovery

Initial jobless claims are declining painfully slowly. The disconnect between the choppy recovery and financial markets creates upward risk for gold.

The initial jobless claims still paint grim picture. They amounted to 1.48 million in the week from June 13 to June 20, as the chart below shows. While the number of Americans who applied for unemployment benefit have been systematically declining since late March, the number of people who applied for receiving jobless benefits barely fell from 1.57 million recorded at the beginning of June.

The falling back toward a pre-pandemic normal level is disturbingly slow (analysts expected lower number) and it casts doubt on the strength of the recovery. After all, millions of Americans are still losing their jobs each week! The so-called continuing claims have been also falling painfully slowly after peaking in mid-May. To some extent, the elevated level of new claims results from too generous unemployment benefits (for many people, being unemployed is more financially attractive that going to work), but in part, it may be caused by weak demand for labor. After all, many companies are now restructuring to adapt to a radically different post-pandemic environment. No matter the reason, fewer people having job is always troublesome for the economy.

Importantly, the resurgence of new Covid-19 infections in many states could make the recovery even weaker, forcing the businesses to scale back and fire people again, if authorities tighten sanitary regulations or consumers start to distance socially again.  

Disconnect Between Real Economy and Financial Markets

Given the choppy recovery, the disconnect between real economy and the financial markets has probably never been greater. And, as the International Monetary Fund’s update on the global financial stability noted last week, the gap between the bullish mood among investors and the enormous uncertainties about the path of the economic is a serious risk to global financial stability:

Amid huge uncertainties, a disconnect between financial markets and the evolution of the real economy has emerged, a vulnerability that could pose a threat to the recovery should investor risk appetite fade (…) This decoupling raises questions about the possible sustainability of the current equity market rally if not for the boost of sentiment provided by central bank support.

Indeed, market valuations appear stretched and “the difference between market prices and fundamental valuations is near historic highs across most major advanced economy equity and bond markets.” Hence, many developments, including the tightening of monetary policy or the resurgence of coronavirus infections, could trigger a repricing of risky assets, which could destroy the economic recovery.

According to the IMF, another important risk for the financial system is high indebtedness, as debts may become unmanageable for some borrowers:

aggregate corporate debt has been rising over several years to stand at historically high levels relative to GDP. Household debt has also increased, particularly in countries that managed to escape the worst impact of the 2007-8 global financial crisis. This means that there are now many economies with high levels of debt that are expected to face an extremely sharp economic slowdown. This deterioration in economic fundamentals has already led to the highest pace of corporate bond defaults since the global financial crisis, and there is a risk of a broader impact on the solvency of companies and households

Implications for Gold

What does it all mean for the gold market? Well, the weaker and more choppy the rebound, the better for gold, as the fragile recovery should assure elevated safe-haven demand for gold. Similarly, the larger gap between the real economy and financial markets, and the longer it lasts, the greater possibility of the financial crisis. In such environment, the yellow metal is an attractive portfolio diversifier, so we would not be surprised if gold crosses $1800 per ounce in the foreseeable future.

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Arkadiusz Sieron, PhD
Sunshine Profits: Analysis. Care. Profits.

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