Gold clears first hurdle of resistance
Gold seems to be breaking its negative correlation to rising US real yields and the Chinese yuan. The yuan and gold have almost been joined by the hip of late, seeing weakness since the Us-china trade war began. However, the emerging softness in US stocks this week combined with the recent rise in bond yields and speculation that the dollar may be peaking have triggered renewed demand for diversification and tailend protection.
The close correlation between gold and the yuan has baffled the market in recent months. While no clear explanation exists, some speculation has emerged that the People’s Bank of China is seeking a stable currency, not against the dollar but against gold. Indeed, XAUCNH (off-shore) and also onshore XAUCNY have traded in a very stable fashion during the recent period. Yesterday, however, the price broke the downtrend from 2016 and while the PBOC has undoubtedly been buying into the recent weakness, we are unlikely to see any selling emerge on renewed gold strength.
Yesterday’s weaker-than-expected US CPI reading strengthened the market’s belief that the Federal Reserve may be making a policy mistake if it doesn’t step away from its “nowhere near normal” stance on rates. Together with a bounce in bonds as stocks continued lower, this narrative helped trigger the biggest one-day rally since June 2016, when the Brexit vote in the UK shocked the market.
Gold has now cleared the first hurdle of resistance at $1,210/oz but in order for this to be more than a weak correction within a major downtrend it needs at a minimum to break above $1,238/oz, the 38.2 per cent retracement of this years sell-off.
The weekly COT report has highlighted the (up until recently) continued build in speculative short positions held by hedge funds. The peak was reached a couple of weeks back when the net-short hit a record 77,000 lots. This was three times bigger than the previous record short from December 2015, which occurred ahead of the first Fed rate hike.
Given the impact of previous periods of shortcovering, a return to a neutral position could see the gold price higher by between $50 and $75/oz.
The break above $1,210/oz this week has changed our short-term view from neutral to bullish. A continued focus on stock, bonds, and growth weakness and the potential of the dollar running out of steam could see the metal embark on a recovery towards $1,300/oz, our year-end target. Much still depends, however, on the overall market sentiment, which has been rattled by rising rates and falling stocks. A correction over the coming days following Thursdays strong gains need to be halted ahead of $1,210/oz in order for this improved technical outlook to take hold.
While the S&P 500 was down 5.4 per cent on Thursday and heading for its worst week since March, the Vaneck Vectors Gold Miners ETF (GDX) was up 6.5 per cent, its best week since January 2017. The exchangetraded fund tracks the performance of and invests in materials stocks of all cap sizes across the globe. Its largest allocation is in North America with Newmont Mining Corp and Barrick Gold Corp accounting for close to 20 per cent of its exposure.