Why Forex Traders Need To Care About Gold's Collapse

by: Kathy Lien

There were some big moves in the foreign exchange market today but nothing compares to the sell-off in gold. In fact, describing the move in gold as a sell-off is an understatement because the 8% decline is the largest single day loss for the commodity in 3 decades. While gold is also considered a form of currency, it is a truly global commodity that is affected by broader and less country-specific factors than traditional fiat currencies backed by individual governments. Therefore, big moves in gold can be an important signal for currency traders. On a daily basis, gold may take its cue from the market's demand for dollars, but this time around, the sell-off in gold is sending a very strong message about investor appetite.

For the past few years, buying gold as an inflation hedge was one of the most popular trades championed by some of the most respected investors around the world. Unfortunately, as time progressed, patience began to wear thin and investors were seeing their investment values dwindle with no hope of rapidly rising inflationary pressures in sight. Consumer and produce price reports also failed to show any major uptick in price pressures as weak demand prevented businesses from raising prices. Tomorrow's U.S. consumer price report should show how benign inflation pressures have been in the U.S. as CPI is expected to have stagnated in the month of March. U.K. and eurozone consumer price reports are also scheduled for release and while price pressures have been stronger in both countries, there are still more downside than upside risks. As a result, with returns in equities becoming more attractive, a larger subset of investors are giving up on their losing inflation hedge and going on the hunt for yield.

The sell-off in gold also reflects concerns about global growth. Between this morning's (Monday) softer U.S. economic reports, last night's weaker Chinese data and this month's disappointing U.S. retail sales and jobs numbers, there are definite signs that the global recovery is losing momentum. The U.S. dollar traded higher against all of the major currencies today except for the Japanese yen, on the back of weaker manufacturing activity in the NY region (the Empire State manufacturing index dropped to 3.05 from 9.24) and a decline in foreign purchases of U.S. Treasuries. Finally, $1,500 was a key support level in gold and when that broke, the sell-off gained momentum quickly. Stops were triggered, margin calls were made and many investors opted to abandon their losing positions than to add margin.

For Forex traders, there's a few important takeaways from the move in gold:

  1. There's no need to worry about inflation until there are significant and sustainable signs of growth

  2. Be worried about the slowdown in China and the U.S.

  3. Beware of how quickly losses can occur when key levels and stops are taken out.

In terms of price action, these concerns could lead to further pressure on major currencies.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.