The price of gold ended last week at a level of just under $2,430 per ounce, which means that the precious metal recorded a small, approximately $10 drop from the price at the beginning of last week. And let us recall that we have a very turbulent period behind us.
After the weekend and the reopening of Eastern markets, the Tokyo stock exchange fell sharply. This was the result of first Japan raising interest rates and then dismal economic data from the United States on employment and unemployment, which in turn raised questions about a recession in the United States.
How did the Tokyo stock market crash happen?
The declines on the largest stock market index in the Land of the Rising Sun, the Nikkei 225, exceeded 12%. Why did they happen? It is “due” to the fact that those who play on the capital market used the so-called carry trade system. It is based on differences in interest rates, or rather in the interest rate on capital between different countries.
For many years, interest rates in Japan were negative, so the Japanese yen was relatively cheap, there was no inflation, and the cost of capital was very low. The capital market therefore borrowed in stable yen, then exchanged them for US dollars, and then bought stocks for dollars.
In a situation where interest rates in Japan are rising and the cost of capital is rising, it suddenly turns out that the profit that could previously be made by exchanging the yen for the dollar is no longer there and losses appear. Therefore, investors began to withdraw their capital in panic. And this caused a huge outflow of capital from the Japanese market.
This of course caused turbulence on other markets, because Monday was difficult for all stock exchanges around the world. The largest indices in the United States also lost a few points, and voices about a recession in the US became stronger. Fortunately, Monday passed, and the situation stabilized.
Investors did not panic and run for gold
Other assets of various kinds, such as gold and bitcoin, also lost value. Only the VIX index, the so-called fear index, used as a hedge against all kinds of crises, grew. It rose to a level we have not seen since the pandemic. And why did gold, which people often flee to in panic, also fall in price?
For a very simple reason. When stock markets are “falling” and capital starts to flow out of them, so-called margin calls appear, i.e. it turns out that there is not enough money to maintain certain positions on the stock exchanges. Phones start ringing that you have to pay extra so that the positions do not close and the losses are not much greater.
As a result, the market began to withdraw capital from various assets in order to have funds to secure these endangered positions. Investors did not buy other assets, but waited for the situation to calm down, to assess what was really happening and how long it could all last.
The next day, Tuesday, the Japanese index gained 10%, but still did not make up for the losses from Monday, and a lot of capital left the market. The situation that we saw last Monday may repeat itself, but the carry trade system that has been used for many years seems to be becoming a thing of the past.
The specter of recession looms over the US
Of course, the fact that investors started to withdraw capital from the stock market so much was not only caused by the carry trade system itself. One of the other factors may be the loss of confidence in the AI sector, which has been "pumping up" stock market results in recent months, and companies dealing with artificial intelligence have grown exponentially.
NVIDIA has suddenly become the most valuable company in the world, with the largest capitalization, competing with Apple. Since June, NVIDIA's shares have already fallen by over 40%. This also applies to other companies in the sector, which have also been reporting large losses recently. Perhaps this is simply a healthy correction and rationalization of this market.
In addition, there is also the aforementioned risk of recession. The world's largest investment banks estimate its probability as very high. JP Morgan pessimistically estimates that the chances of the United States falling into recession are already 50%, among other things due to delayed actions by the Fed, and Goldman Sachs raised its indicator from 15% to 25%,
What's more, JP Morgan CEO Jamie Dimon says that the Fed's achievement of the 2% inflation target won't happen anytime soon and that we'll be "riding with" this inflation for some time. Add to this the doubts about the condition of the American economy, and the situation of the United States in this regard really doesn't look good.
What will the Fed do?
The market is no longer wondering whether interest rate cuts will occur in September, it is only pricing in how deep they will be. Not long ago we were talking about 25 basis points, and now we are increasingly hearing that it will be 50 points or more. Currently, it is also said that it will not end with one cut, there are voices about three.
If this really happens, then by the end of 2024 interest rates could be as much as 1.5% lower than they are now. This would mean a very high and very fast cut. We'll see if the Fed decides to do this. If it does, it will be a clear signal that the economic situation in the United States is indeed very, very difficult.
Prepared by: Michał Tekliński, gold market expert
