Gold under pressure

By David Morrison  |  16/05/2018 13:58

On Tuesday gold crashed below $1,300 to hit its lowest level since the end of last year. The move has come about as the US dollar continues to rally and as the 10-year Treasury yield hit a 7-year high.

Gold had shown remarkable resilience over the past few weeks, holding above $1,300 despite the upside breakout in the US dollar. Less than a month ago the Dollar Index surged through resistance around 90.00, a level that had held on an end-of-day basis for most of the period since mid-January. Despite some analysts cautioning that the dollar move could prove to be a false breakout, the greenback has continued to rally. It pushed higher again today to hit its highest level this year, driven to a large degree by a sharp spike up in US bond yields.

On Tuesday the yield on the 10-year US Treasury note briefly broke above 3.09% - a level not seen since July 2011, while the 2-year hit its highest yield in close to 10 years. Rates have been pushing higher ever since the summer of 2016 as the Federal Reserve made in clear that they were intent on tightening monetary policy. Inflation (as recorded by Core PCE, the Fed’s preferred measure) is now hitting the central bank’s 2% target. The Fed has made it clear that they will be quite relaxed to see inflation push well above the target rate, implying that they will continue to raise rates and reduce their balance sheet at a steady pace, rather than accelerating their tightening programme. At the same time, it has also become apparent that new Fed Chair, Jerome Powell, is unlikely to follow in the footsteps of his predecessors, Ben Bernanke and Janet Yellen, in pausing monetary tightening should equity markets have another tumble. So, real interest rates, that is once inflation is subtracted, should be mildly positive for gold currently, given that Core PCE is running ahead of the fed funds rate.

But yesterday gold took an almighty tumble which saw it close below the 200-day simple moving average (SMA) around $1,307. The last time this happened so decisively was at the end of last year. Gold fell around 3% from the 200-day SMA to bottom out around $1,236. But once the speculative longs had been forced out, prices rebounded rapidly and gold then rallied 10% over the next six weeks hitting $1,366 which remains the high for this year. There has been some speculation that this current move in gold may be a price wash-out engineered to drive speculative leveraged long position holders out of the market. If gold were to repeat its move at the end of last year, then a 3% pull-back from the 200-day SMA would take it down to around $1,267 although some traders haven’t ruled out a retest of the December 2017 low.

The frustration for gold bulls is the feeling that there is so much uncertainty around the world and that this should be keeping a solid bid under the precious metal. After all, gold is still considered by many to be the ultimate safe haven. Overnight we heard that North Korea’s leader Kim Jung-un is prepared to pull out of talks with President Trump planned for June 12^th, if the US insists that North Korea gives up its nuclear weapons. In addition, Italy is back in the spotlight as it looks as if the Northern League and Five Star Movement are on the brink of forming a coalition government. Unfortunately for the European Union, the agreement between the two parties includes a demand that the European Central Bank cancels €250 billion in Italian debt. This caused Italian bond yields to surge. Unfortunately for gold bulls this also saw the euro fall sharply and the US dollar make further gains, providing another excuse to sell the precious metal.

 
 
Looking at the chart we can see some mild support around the $1,280 level. The red line is a rough trendline taken from the multi-year low hit in October 2015, and this is also close to the 61.8% Fibonacci Retracement of the December 2017 – January 2018 rally. But so much depends on what the dollar does now and how many gold holders were forced to cover in yesterday’s sell-off. If the dollar rally continues and large speculators remain net long, then gold could fall further. Given that ominous ‘double top’ the danger is that prices retrace the whole of the Dec-Jan rally and end up retesting the $1,236 low. But if that were to happen, it seems reasonable for traders to expect a repeat of the move earlier this year and look for a sharp recovery.



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