Solid Support for Gold in Second Half
Gold continued its range-bound pattern in June, fluctuating between US$1,200 and US$1,300 per ounce since January.
Gold reacted to Fed hawks in June
Gold continued its range-bound trading pattern, fluctuating between US$1,200 and US$1,300 per ounce since January. In June the price fell US$27.39 (-2.16%) to end the month at US$1,241.55. On 14 June, the Fed raised rates for the fourth time in this rate hiking cycle. A common pattern emerged for the first three rate hikes with gold price weakness ahead of the hikes, followed by a rally to higher prices immediately after each hike. This time that pattern changed, as gold reached its high for the year (US$1,298 per ounce) on 7 June before the hike then trended lower for the rest of the month. Gold came under pressure as hawkish statements by the Fed following the Federal Open Market Committee (FOMC) meeting raised the odds of a fifth rate increase later in 2017.
The US dollar gained strength temporarily following the FOMC meeting, but ended June with a 1.4% loss, as measured by the US Dollar Index (DXY Index), which fell to nine month lows. The weakness was caused by comments from top officials from the European Central Bank and Bank of England, which the markets interpreted to suggest that some removal of monetary accommodation could be warranted soon. Also weighing on the U.S. dollar was the International Monetary Fund's downgrade of its 2018 U.S. GDP growth forecast to 2.1% from 2.5%. The global economy appears to be set to outpace the US economy over the coming year.
Gold hurt by intense selling pressure
The June performance of gold was disappointing given the weakness in the US dollar. Gold normally has an inverse correlation with the dollar. However on 26 June, before European markets opened the futures market was hit with a 1.8 million ounce sell order that drove the price down US$18 in an instant. The selling came during off hours when liquidity was light and it pushed the gold price below the technically important US$1,250 per ounce level.
Further selling pressure on the day before the Fourth of July holiday in the US had gold testing the US$1,200 level. We have not seen this type of selling pressure since the bear market period from 2013 to 2015.
Poor results for gold equities
Gold stocks were mixed in June. The NYSE Arca Gold Miners Index (GDX Index) followed gold lower with a loss of 5.73%.
Waiting for a strong catalyst to propel gold off its base
Since the bear market ended in December 2015, the price of gold and gold shares has been forming a base. Thus far in 2017, U.S. dollar weakness and a general nervousness on many geopolitical fronts have provided solid support for gold as a currency alternative and a hedge against risks. Gold ended the first half of 2017 with a modest gain of 7.75%. Gold stock indices underperformed gold as the GDX Index fell 0.60%. We normally expect gold stocks to outperform gold in a rising market. The underperformance of the indices this year is likely due to mean reversion after stellar outperformance in 2016 and heavy net redemptions in the gold mining ETFs.
Support exists for current price levels
The market is now in the middle of the summer doldrums, a time when physical demand is at its lowest and trading volumes can be light. The gold price is testing the US$1,200 per ounce level for the third time this year. If US$1,200 fails, then it will go on to test the US$1,175 base of the uptrend that has developed over the past 18 months. Successfully holding above these price levels would be very positive technically and psychologically for the market. Fundamentally, we believe the market is well supported around current levels because:
- Physical demand in India and China continues to improve, even though the People's Bank of China (PBOC) has yet to buy gold in 2017. We believe the PBOC is on pause this year due to foreign exchange and debt issues in China;
- Geopolitics in the Middle East and Korea—along with uncertainty surrounding the US political climate and policy—has created a pervasive nervousness globally that benefits gold;
- The US dollar appears to be in decline. While it did not help gold in June, we expect the historical negative correlation to benefit gold in the longer term;
- Positioning in the futures market suggests there could be more buying ahead.
Gold remains a solid money alternative given financial risks
Gold would likely benefit from US dollar weakness if the Fed is unable to raise rates later this year. In the longer term, when the economy and markets eventually see a downturn, the risks to the financial system will probably be substantial. Historically, excessive leverage is the core cause of financial upheaval. In the US student loans, automotive loans, and credit card debt are each over $1 trillion now. The "elephant in the debt room" remains sovereign debt levels that exploded higher after the last financial crisis and have been growing ever since. A shrinking economy magnifies debt problems and with interest rates still far below normal, would likely see the Fed resort to quantitative easing again and maybe more extreme intervention, such as debt monetisation. Gold and gold miners have been used by investors as a hedge against such risks.
Published: 09 August 2018
