Why Gold Is Glittering

Inflation in the UK is still a concern, with prices in stores rising at the highest rate on record in March on the back of a sharp increase in food prices. Unfortunately for Brits, the cost-of-living crisis is far from over. Chinese giant Alibaba, meanwhile, announced plans to split its $220 billion empire into six business units to unlock shareholder value and deflect regulatory pressure. Elsewhere, savers are pulling cash out of bank deposits at record rates and parking the dough in money market funds, which have higher interest rates and more perceived safety amid the ongoing turmoil in the banking sector. Finally, traders are betting on further increases in the price of gold even after it touched a 12-month high in March. Find out why in this week’s review.

Macro

Inflation in the UK unexpectedly accelerated in February, leaving Britain as the only G7 nation with inflation still stuck in double digits. Brits were left hoping that things would cool down in March, but fresh data out last week might throw cold water on those dreams, with prices in UK stores rising at the highest rate on record in March. More specifically, shop price inflation accelerated from 8.4% in February to 8.9% last month, led by a 15% increase in food prices due to fruit and vegetable shortages. That’s a fresh peak for the shop price inflation measure, which started in 2005.

The data is the latest sign that the cost-of-living crisis in the UK is far from over. Energy bills remain high, and consumers are feeling the pressure on their personal finances. The Bank of England predicts inflation will fall below 4% by the end of the year, but many Britons don’t believe it. A survey by Deltapoll conducted last month showed that, on average, people expect inflation of 9.4% a year from now…

Stocks

Chinese giant Alibaba announced plans last week to split its $220 billion empire into six business units, freeing up the company's main divisions to operate with more autonomy. The radical breakup is aimed at unlocking shareholder value and deflecting regulatory pressure off its empire. Under the restructuring, Alibaba’s six new business groups will be dedicated to cloud computing, ecommerce, local services, logistics, digital commerce, and media. In a letter to employees, the firm’s chief executive said that each business unit can pursue independent fundraising and IPOs when they are ready.

Over the past two years, Alibaba has dealt with a record $2.8 billion fine by Chinese regulators for monopolistic behavior and seen its growth slow down on the back of the country’s zero-Covid policies and a rush of new ecommerce competitors. These factors combined have helped wipe out more than $500 billion off Alibaba’s market value since October 2020. But investors definitely liked the sound of the firm’s breakup plans, sending its US-listed shares up 14% after the announcement. Other Chinese tech giants (such as Tencent) also surged in anticipation that Alibaba’s peers might explore similar actions.

Bonds

Investors are pouring cash into US money market funds, with more than $286 billion worth of inflows in March alone, making it the biggest month of inflows since the depths of the Covid-19 crisis. Money market funds hold low-risk, highly liquid fixed-income securities, including short-dated US government debt. The strong inflows have helped push overall assets in these funds to a record $5.1 trillion last week.

There are two key factors driving the surge of inflows. First, the collapse of two regional US banks and the rescue deal for Credit Suisse are raising concerns about the safety of bank deposits, pushing savers and businesses to look for alternative safe havens to park their cash. This is especially the case among large depositors who hold more than the $250,000 limit insured by the Federal Deposit Insurance Corporation. Second, the yields available on money market funds are now the best in years as they rise with interest rates, which have been lifted to 15-year highs by the Fed.

The following, from a research note last week by Barclays strategist Joe Abate, sums up the current situation perfectly: “The recent tumult regarding deposit safety may have awakened "sleepy" depositors and started what we believe will be a second wave of deposit departures, with balances moving into money market funds. Until this week, depositors appear to have paid little attention to the unsecured risk they faced with balances above the insurance cap. And they seem to have largely ignored the low interest rate paid on their deposits.”.

The exodus of deposits isn’t just a US problem. According to data published by the European Central Bank last week, depositors have withdrawn €214 billion from eurozone banks over the past five months, with outflows hitting a record level in February. In the UK, corporate customers withdrew £20.3 billion from British banks in January – a record since this data started being collected in 2009. Banks in the eurozone have been particularly slow to pass on higher interest rates to depositors, prompting savers to move their cash into higher-yielding alternatives like money market funds and fixed-term savings products.

Commodities

Traders are betting on further increases in the price of gold after it touched a 12-month high in March. That comes alongside a big surge in activity across all financial instruments tied to the shiny metal, including futures contracts, ETFs, and options. In fact, March is set to be the first month of net inflows into gold ETFs in almost a year. But the bets on a further gold rally are most pronounced in the options market, with the five-day rolling volume of call options on the SPDR Gold Trust ETF surging more than fivefold in March. What’s more, the ratio of calls to puts has swung to extreme levels, suggesting a consensus among traders that prices are on the way up.

There are several reasons why traders are bullish on gold. First, the ongoing turmoil in the financial sector is increasing demand for safe-haven assets like gold. Second, the bank crisis has led investors to reconsider their interest rate expectations in the US. See, rising rates over the past year have reduced the attractiveness of gold, which generates no yield. However, traders are now betting that the Fed's most recent rate hike will be its last, and are pricing in around 50 basis points worth of rate cuts between now and the end of 2023.

Third, the prospect of lower interest rates in the US is reversing some of the extraordinary gains witnessed by the US dollar over the past two years. That’s good news for gold, which tends to move in the opposite direction to the dollar. Fourth, if the Fed does indeed pause or cut interest rates to avoid further stress in the banking sector, then it’ll essentially be prioritizing financial stability over price stability. Put differently, a premature end to the Fed’s rate hiking cycle could cause inflation to remain elevated for a while. That would bode well for gold, which is often viewed as a hedge against inflation.

This week

• Monday: China manufacturing PMIs (March).
• Tuesday: Reserve Bank of Australia interest rate announcement, eurozone PPI (February), US factory orders (February).
• Wednesday: German manufacturers' orders (February).
• Thursday: China services PMIs (March), UK house price index (March).
• Friday: US labor market report (March), Japanese household spending (February).