(Wallace Refiners) From a mathematical perspective, Quant Insight sees gold’s current trading levels as “cheap,” especially with safe-haven plays dominating the market.
Gold looks like a bargain after plunging back down towards the $1,800 an ounce level during the last few sessions in light of the upcoming Federal Reserve’s aggressive rate hikes, Quant Insight’s head of analytics Huw Roberts told Wallace Refiners.
“We have gold as cheap on our models, anywhere between 5% to 7% undervalued, depending on which time horizon you’re looking at,” Roberts said this week.
Quant Insight’s algorithm is all about the macro drivers. It looks at economic fundamentals, such as growth and inflation, and financial conditions — whether the real yields are rising, the yield curve is flattening, or the dollar is getting stronger, explained Roberts.
“We run any asset, whether an equity, a bond, or a commodity. And we train the price action of that asset on those macro factors. And then it’s all down to the algorithms. There’s no discretion whatsoever. This is where we differ from the majority of the research world — our view is 100% systematic,” he said.
After putting it all together, gold looks undervalued, but there is one caveat — the level of confidence of the algorithm.
“The algorithm produces a model confidence number, which basically means ‘goodness of fit’ — how effective the model is at displaying price action in the assets at the moment. And our threshold is above 65% for any signal to be valid. And right now, although we have gold as cheap, the model’s confidence is around 50%,” Roberts added.
What this means for investors is that maybe it is too early to rush to buy the dip, but the precious metal must be high on the radar.
“We’re not quite at the threshold, so we wouldn’t go out and bang the drums and say now is the time to buy the dip. Rather, we would say gold is undervalued relative to prevailing macro conditions. But because we are below that 65% threshold, we are not in the macro regime, and it’s more the metal to watch,” Roberts clarified.
The two dominant drivers for gold are risk aversion and credit spreads. The latter is an excellent measure of financial conditions, especially when the Fed is tightening its monetary policy.
“Credit spreads are a big driver for gold at the moment. And if we get risk-off, higher VIX, and wider credit spreads, that’s good for gold. Gold is trading like a safe-haven play for us at the moment,” Roberts pointed out.
Gold’s safe-haven appeal is a more prominent driver than its inflation-hedge side. “We do have signs of inflation being a positive driver as well. But it is the safe-haven hedge that is dominating right now,” Roberts added. “Gold is currently outweighed more by the relationship with VIX and credit spreads.”
In the meantime, the traditional relationship between gold and real yields has broken down, which is important to keep in mind. “The normal relationship has flipped completely. It turned positive — higher real yields, higher gold — in March. Most of the time, the relationship is negative — when real yields are low, people aren’t earning any interest, and therefore they look for other assets, and gold could be one of them,” Roberts said.
At the time of writing, June Comex gold was trading at $1,839.30, up 1.29% on the day, driven by a lower U.S. dollar index and a volatile U.S. stock market.
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