The Fed, U.S. Treasuries, The Fundamentals, The Technicals - All Point To A Further Gold Rebound

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 |  Includes: DGL, DGP, GLD, IAU, SLV, UGL
by: David White

The U.S. dollar is the current reserve currency of the world. As such, it has the largest effect on the price of gold, which has historically been the world's common currency for thousands of years. When the Fed recently hinted it might begin tapering its bond buying program (MBS and U.S. Treasuries) perhaps as early as September 2013, U.S. Treasury Bond yields began to rise rapidly in May 2013. The 10-year U.S. Treasury note yield has risen from 1.63% on May 2, 2013, to a high of 2.61% on June 25, 2013. This is a huge change for such a short period of time.

Since the value of the U.S. dollar usually goes up as U.S. bond yields rise, gold has become less valuable. It is often sold/traded in U.S. dollar terms. Furthermore, if the current reserve currency, the U.S. dollar, gains in value this most often translates into a fall in the value of the world's historical common currency -- gold.

The one-year chart of the 10-year U.S. Treasury note yield (below) shows this rapid rise in the yield is likely to give back some of its recent gains. In fact, it already has. The yield as of this writing on July 2, 2013, now stands at 2.46%. This is down significantly from it recent high of 2.61%. Many believe this reversal is due largely to the recent Fed governors' propaganda campaign to reassure the public about the market and about U.S. Treasury bonds. The price of gold should move in inverse direction to the yield of the 10-year U.S. Treasury note. As the yield decreases (the U.S. dollar decreases in value), the price of gold is likely to go up.

Yes, the 10-year U.S. Treasury note yield has already fallen back to 2.46%, but the chart shows that the first good support level is at approximately 2.21%. If this proves to be the level that the yield falls to soon, gold prices should rise considerably from their current level in the near term. Using the SPDR Gold Shares ETF (NYSEARCA:GLD) as a proxy for gold, one can see that GLD was $133.94 on June 10, 2013, at the same time that the U.S. Treasury 10-year note yield was at 2.21%. The GLD one-year chart below shows that GLD has strong resistance at approximately $134 due to previous consolidation at that approximate price point.

Click to enlarge image.

Click to enlarge

The GLD slow stochastic sub chart shows that it is at oversold levels, even after its move up in the last two days. The main chart shows that the GLD price is far below its 50-day SMA and its 200-day SMA. Technically, this indicates an increased likelihood of a near-term upward bounce.

The slight beat in the euro area Markit Manufacturing PMI at 48.8 vs. an expected 48.7 and a previous 48.3 helps the idea of a rally in gold. If the European economies are a bit stronger than expected, then gold is more likely to rise. Many will see inflation as a more likely possibility.

An earlier article I wrote, titled "10 Reasons To Beware This Market Both Short And Long Term," provides many reasons that the 10-year U.S. Treasury note yield is more likely to keep falling near term than to keep rising. There is unlikely to be inflation if many of the world economies are slowing. This is a double-edged sword, as it may eventually mean gold will fall more as the world economies weaken further over time. In that case, gold is more likely to fall further as more people turn to the U.S. dollar as a safe haven.

However, in the near term, this overall world economic weakness means that rampant inflation is unlikely. It means that the recent rapid rise in the 10-year U.S. Treasury note yields is likely over done. If there is no big inflationary pressure, the safe haven U.S. Treasury yields should go down rather than up. This translates into a weaker U.S. dollar as fewer people want to own U.S. dollars or U.S. Treasuries when the yields are lower. That in turn translates into a likely higher price for gold. This is especially true if gold is set up for a big technical rebound upward.

Another factor that implies a rebound in gold is gold's production cost. The cost of mining the gold itself may amount to about $730/ounce. However, you have to add the cost of exploration and acquisition to that. Many now feel that the real cost of producing an ounce of gold on an ongoing basis is in the area of $1,300/ounce. This itself should provide a floor under gold prices. Gold prices recently went through that floor down to $1,179.4/ounce. Nymex gold prices are now on a rebound at about $1,251/ounce as of today, July 2, at the time of this writing.

Gold has a long way to go to get back to the experts' estimated lowest long-term base price of $1,300/ounce. On June 10, 2013, Nymex gold closed at $1,386.5/ounce. This is the gold price that correlates with the GLD consolidation price of approximately $134. Gold has a long way up to go to get to this price, and this price only seems minimally above the experts' estimated base price of $1,300/ounce.

The only big problem I see to the above thesis is that the overall market may fall in the near term. If it does, it may take gold prices down with it. Deutsche Bank said July 1, 2013, that it sees the S&P 500 holding above 1525 as a bottom in mid-July 2013. If Deutsche Bank is correct, then we may see the S&P 500 fall from its current $1,606.50 as of this writing, July 2, 2013, to a much lower level near term. If you believe Deutsche Bank at all (and it is one of the major players), you want to account for this in your trading. If you buy GLD, you may have to abide some short-term pain. If you buy options, you may want to buy one- to two-month options to make sure you allow enough time for a down move and a rebound.

A final consideration is the long-term theme of the "10 Reasons To Beware This Market Both Short And Long Term" article mentioned above. This article suggests that there may be a 50% fall in the overall market in the next one to two years. If that happens, gold prices will likely fall along with the rest of the market. This may make call options on GLD (or a call option spread on GLD) a more attractive way to make a rebound play. The options will limit possible losses.

In addition to the GLD ETF, there are many other ETFs that can be used, such as:

  • iShares COMEX Gold Trust (NYSEARCA:IAU)
  • Power Shares DB Gold Fund (NYSEARCA:DGL)
  • Power Shares DB Gold Double Long ETN (NYSEARCA:DGP)
  • ProShares Ultra Gold ETF (NYSEARCA:UGL)

Alternatively, one can buy gold futures or physical gold. Furthermore, many of the same arguments can be made for other precious metals, especially for silver. The iShares Silver Trust ETF (NYSEARCA:SLV) is perhaps the most common trading vehicle for silver.

Note: Some of the fundamental financial data above is from Yahoo Finance.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in GLD over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.