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A pause in gold’s decline

By David Morrison  |  25/07/2018 14:58
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Gold has slumped since April as the Fed tightens monetary policy and the dollar rallies. Has it got further to fall, or could it be about to reverse direction?

Earlier this year gold popped its head above $1,360 to hit its highest level since August 2016. It spent the next few months probing this area of resistance while occasionally dipping back below $1,320. But after another failed attempt to break and hold above $1,360 in April, gold reversed direction and sliced below previous significant support levels. Only yesterday it traded below $1,220 for a loss of around 10% over the last three months.

Gold priced in dollars

This is all about the price of gold in US dollars as that is the currency in which it is traded on the world’s main exchanges. And typically, the dollar price of gold will fall when the dollar itself is going up. Since mid-April the Dollar Index is up around 5%, so that certainly explains some of gold’s losses. But is that the whole story?

Gold as insurance?

After all, we live in uncertain times with an unpredictable figure in the White House and the threat of a full-blown trade war to contend with. Surely there must be some investors anxious to pick up gold as a bit of insurance? If there are, they appear to be in no rush to buy. Maybe most are convinced that at some stage they’ll be able to pick it up cheaper than the 12-month low where it currently trades.

Divergent monetary policy

The rally in the dollar is a direct result of higher bond yields which are up on expectations that the US Federal Reserve will continue to tighten monetary policy. This comes as other developed-world central banks (primarily the European Central Bank (ECB) and Bank of Japan (BOJ)) keep monetary policy loose. In addition, China, the world’s second largest economy by GDP is adding stimulus.

Watch the yuan

Yesterday the Chinese yuan hit a 13-month low versus the US dollar. This represented a decline of over 8% since the middle of April. This was when the Chinese authorities loosened monetary policy when they made an unexpected cut to the Reserve Requirement Ratio for banks. On Monday China announced further fiscal stimulus. The Trump administration may label this as outright currency manipulation by the Chinese authorities – a deliberate move to devalue the yuan and thereby offset the negative effects of US tariffs on Chinese imports. But this additional monetary and fiscal stimulus is probably more in response to a slowdown in Chinese economic growth – something which may be happening at a far faster rate than indicated by official data. Whatever the reason, gold traders should pay close attention to the yuan going forward.

Inflation has risen

Along with the dollar, rising bond yields also dampen demand for gold. The reason typically given is that investors can get a decent “risk free” return by holding interest-paying US Treasuries. But this ignores the effects of inflation which eats in to any interest rate gains. The fed funds rate is around 2%, the highest of any developed-world central bank and predicted to be around 50 basis points higher by year-end. But inflation is also picking up. Headline CPI stands at 2.9% - easily eating up the yield on a 2-year Treasury Bill. Even the Fed’s preferred inflation measure, Core PCE, is running at 2.0%. Considering this alone, gold may not be an unattractive asset after all.

Cloudy chart outlook

Looking at the chart there’s some support for gold around $1,220 with minor resistance at $1,240 and then $1,260. The Commodity Channel Index has also perked up a bit recently. However, the overall trend remains negative and a few closes below $1,220 raises the probability of a move to $1,200 or lower.
 
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Any information, analysis, opinion, commentary or research-based material on this page is for information purposes only and is not, in any circumstances, intended to be an offer of, or solicitation for, a transaction in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. Any person acting on it does so entirely at their own risk and GKFX accepts no responsibility for any adverse trading decisions. You should seek independent advice if you do not understand the associated risks.
 

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