Gold remains trapped between competing forces. Persistently high and rising levels of inflation in major economies are lending support while the hawkishness from central banks, to control the inflation, is creating headwinds. Gold has held its ground relatively well in the face of the sharp rise in US Treasury yields and an appreciating dollar and many investors are still recognising its value as a diversifier – given it is broadly flat this year while equities have endured large losses. For this reason, physical gold held in exchange traded products worldwide stands elevated at just under 105 million troy ounces (oz) as of 24 June, compared to around 98m oz at the start of the year. Going forward, if stagflationary risks increase, i.e., the risk of high inflation and disappointing growth, gold could remain supported. Most recently, G7 countries have announced a ban on Russian gold. While the physical impact of this decision may be relatively limited given the quantity of gold exported by Russia to G7 countries is not material enough to impact gold prices, the symbolic decision could impact sentiment – potentially through higher net speculative positioning, although this remains to be seen.

Industrial metals have given back their first quarter gains and are now down year to date. The second quarter has been a challenging period for the sector and started with much of the geopolitical risk premium eroding from prices. Prices have continued to decline as slowdown in demand from China (as evident from contractionary Purchasing Managers' Indices (PMI) numbers since March) has weighed on sentiment. Going forward, the growing risk of recession could continue to weigh on sentiment. Industrial metals are somewhat behaving like growth stocks in the current environment, and understandably so. The sector has an element of cyclicality given its strong connection with economic activity and an element of growth given its demand prospects from the long-term energy transition theme. The dampening of risk sentiment has hurt industrial metals on both fronts.

Stocks have been unable to build any positive momentum as concerns over the economic outlook continue to grow. Central banks are expected to employ a wider range of tools at their disposal to tame inflation. Investors are increasingly expecting this to create recessionary risks while inflation may remain stubbornly high due to supply side pressures. Most recently, UK’s consumer price index (CPI) inflation has come out at 9.1% for May, up from 9% in April.

China’s manufacturing Purchasing Managers’ Index (PMI), a measure of month-on-month change in economic activity has been in contractionary territory for 3 consecutive months since March. This has weighed on the sentiment towards industrial metals which rely on support from Chinese industrial demand. If Chinese economic activity offers an expansionary reading for June, this could help revive investor sentiment towards industrial metals.

Industrial metals are currently under the hammer. The pullback in prices started in April when markets started removing some of the geopolitical risk premium baked into prices. Neither US nor Europe have imposed outright bans on Russian exports of industrial metals. Sentiment has remained bearish for industrial metals in May and June due to weak industrial demand from China where the zero covid policy is still being pursued. 

The US consumer price index (CPI) inflation rate for May came out at 8.6%, up from 8.3% the year before. This did not help risk sentiment in equity markets which are now expecting the US Federal Reserve to make a bold move to bring inflation under control. The CBOE Volatility Index (VIX) spiked again to around 34 on 13 June 2022 continuing the pattern of frequent spikes we have seen all year.

As expected, the US Federal Reserve has implemented a 50bps interest rate increase for the first time since 2000 and accompanied it with a signal for further such increases in its subsequent two meetings. But given markets were largely expecting this hawkishness from the central bank, the move has not weighed on sentiment towards gold. Rather, investors are taking the view that the Fed will be cognizant of US economic growth and might not be as hawkish for the rest of the year as is currently priced in. If that is indeed the case, we may see the US dollar and Treasury yields pulling back and gold maintaining its strength. 

Both Brent and WTI (West Texas Intermediate) benchmarks have risen again at the start of May as the European Union is mulling expanding its sanctions on Russian oil. In addition to the ban on Russian oil and gas (which could take up to eight months to come into effect), the European Commission has proposed that companies incorporated in Europe no longer be allowed to transport or insure Russian oil deliveries, irrespective of the final destination. This move is expected to further increase the demand for non-Russian oil which is causing prices to rise. 

The combination of elevated geopolitical and economic risks, and rising inflation is keeping gold demand strong. Net speculative positioning in gold futures (a measure of sentiment), is close to 300k net long contracts . This is around one standard deviation above the preceding 5-year average. Similarly, physical gold held in exchange traded products has risen to around 107m troy ounces (as of 19 April 2022) compared to around 98m troy ounces at the start of the year.

Around 40% of world palladium production comes from Russia putting the metal among the ones most impacted by the conflict. Before the war started, however, we took a constructive view on palladium demand on account of an improved outlook for the automobile industry this year. The conflict has, however, created a lot of uncertainty for palladium on two fronts. First, prices are expected to fluctuate as the situation unfolds. And second, the case for an improved fundamental outlook for automobiles rested on the provision of more semiconductors to automakers this year. Ukraine and Russia, however, are both key suppliers of neon – used in making semiconductors. A question mark on the outlook for the semiconductor industry could, yet again, create headwinds for palladium.