Is gold back?
While torrents of volatility swirl around global equity and commodity markets and currencies bounce around on waves of uncertainty one asset has been quietly powering higher since late December 2015 and its gold. Is this just the beginning?
In many respects the ingredients for a gold rally are ideal. Ultra-loose monetary policies abound, there are rapidly escalating social and geopolitical tensions, financial markets are volatile and the outlook for the global economy is looking increasingly gloomy. There's even growing nervousness over the state some commercial bank balance sheets, despite the strides they’ve made in recent years to become more robust.
The big rally got going around 2002 as prices started to move over the $300 troy/oz barrier and where given a huge boost by the 2007/8 financial crisis. Fear and volatility was off the scale and central banks injected huge liquidity into financial markets helping to lift gold prices from around $700 troy/oz to a peak of $1,921 in Sept 2011. From Sept 2012 the descent from $1,770 has been rapid and steady before bottoming out at just above the psychologically important level of $1,000 and is now just below $1,200, its highest level since June 2015.
In USD terms gold still has a steep hill to climb before taking out it's Sept 2011 highs -- but in a number other currencies, particularly for some of the embattled emerging market ones, this high has already been taken out.
Should the financial turmoil continue and the US Federal Reserve puts the brakes on or even reverses its interest rate rise then the gold rally could well continue and move above $1,300, which is another psychologically important level.
But more fundamentally, central banks are net buyers of gold led by China and Russia.
The People’s Bank of China has been adding to its gold reserves regularly. Intriguingly, this is happening at a time of falling Chinese foreign exchange reserves. The USDs and US Treasuries that are being sold are not just being used to prop up CNY, but also to diversify into gold. One reason for this could be to give CNY a more ‘solid’ backing. In terms of gold reserves China (~1,700 tonnes) ranks fifth in the world and could have plenty more buying to do if, as the world’s second largest economy, it wants to build reserve levels close to what the US (~8,130 tonnes) or even Germany (~3,380 tonnes) claim to hold.
Added to that some, $2.6 billion has been invested into precious metals exchange-traded funds this year and bullion assets held through ETFs are at the highest since July.
In the short-term it will be interesting to see if gold can hang on to its gains after the traditional Chinese lunar new year buying spree. But more fundamentally, net buying from central banks, ongoing uncertainty in the world economy and stock market volatility should continue to play in gold’s favour for the time being.
A longer-term test for gold is if the current doom and gloom turns out to be overdone and risk assets, such as equities and emerging market currencies recover strongly. If that happens, investors may feel they don’t need ‘end of the world’ insurance policies inherent in assets such as gold.
TECHNICAL ANALYSIS: Gold – Still uncertainty if rally is for real
Gold has had a vigorous rally since late December, taking it from just above $1,000 a troy/oz to just under $1,200. The big question is whether it’s just a flash in the pan or part of something bigger.
After all, as gold sunk lower over the last few years, it managed numerous short sharp rallies, typical of short-covering. This latest move looks very similar in nature; which traders should keep in mind. After all the other short-lived rallies also occurred against a backdrop of very negative sentiment towards gold (markets often turn when sentiment is most negative towards them).
So what could be different this time?
There are a couple of things. Firstly, most of the price spikes happened very soon after falls in the price. This time, the market consolidated just above $1,000 for just over a month. This may imply that some genuine long-term long positions may have been built up in gold.
Secondly, is general market sentiment. Anything with a whiff of risk, such as equities, is being dumped and questions are being posed over potential fault lines in the global economy and the financial system.
Increasingly fear driven investor sentiment should benefit gold, especially if the US Federal Reserve puts its monetary tightening on hold due to deteriorating conditions in financial markets and the global economy.
The current rally won’t be able to carry on rising at this pace for much longer. Therefore, for it to have conviction it would need to show some consolidation preferably above $1,100 or even better at $1,200. Otherwise if sinks back to just above $1,000 it will have been little more than another one of those momentary spikes and the next big move could occur below the psychologically important $1,000 level.
In other words, the price action hasn’t yet instilled enough conviction that this is the beginning of a real long-term recovery for gold prices.
Support is placed at 1,173.00, 1,153, 1,125 and 1,047 with resistance around $ 1,200, 1,205, 1,215 and 1,250.
By Justin Pugsley, Markets Analyst, MahiFX