Gold (GLD) is currently at an inflection point. After rallying strongly through 2010 and the first eight months of 2011, gold has retreated slightly and stayed in a mostly range-bound pattern of consolidation. However, the flatlining can't last forever. While in the long term, the macroeconomic conditions needed for a gold uptrend look strong, many investors see gold heading a little farther down in the near future. For those not already holding gold, analyzing the short to medium term factors influencing the gold price can be useful in determining an appropriate entry point.
Factor 1: Europe and the Dollar - Short Term (1-2 months)
The European turmoil has affected American markets in two ways. First, and most obviously, investors panic and go risk-off every time a headline breaks out of Europe. Second, in the context of the weak financial situation in Europe, the dollar looks like the best of a bad bunch. As reported in the Wall Street Journal:
For the second half of 2012, economists at J.P. Morgan Chase & Co. have reduced their estimate for global growth to an annual rate of 2.1% from 2.6%. They expect the U.S. to expand above the pace of the rest of the world-that could make the U.S. dollar even more attractive, pinching exporters.
While the strength of the dollar is critical to the general US equity market, it is also an important factor in the precious metals sector. Gold (and to a lesser extent, silver (SLV)) have a negative correlation with the dollar index -- as the dollar gets stronger, the metals drop like rocks. As the dollar weakens, the metal sees a rally.
(click to enlarge. Source: Ycharts.com)
So can the dollar continue the recent strength trend? In the long term, I find this highly unlikely. However, with Europe in full bailout mode, the dollar may continue to show strength in the near term -- which would be a bad sign for gold bulls.
Factor 2: The Fed - Medium Term (now - year end)
The title of a recent Barron's article says it all: Gold Loses Its Mojo As Bernanke Stands Pat. Quantitative easing and similar Federal Reserve actions have been the gold market's best friend. Gold bulls might want to take note that the market support may be pricing in QE3, and if Bernanke doesn't cooperate, some of that support may evaporate. As stated by Tom Essaye, editor of the 7:00s Report:
This somewhat refutes [Fed Vice Chairman Janet] Yellen's comments from last night and puts any additional easing for the June meeting as pretty unlikely. That being said, there's strong support [for gold] at the $1600 level, as generally the market feels that QE3 or more accommodation is just a matter or 'when' and not 'if'.
If QE3 doesn't pan out, the market might see new lows.
Factor 3: Risk On, Risk Off (now - year end)
As I established in my recent article about the silver outlook, precious metals markets have been pulling something of a Karate Kid over the past few years. Gold, silver, and other PMs are grouped in with equities as "risky" assets that are dumped on the first hint of bad news. In recent history, you'll notice that they show something of a short term correlation with the S&P (SPY) -- up periods and down periods match up for the most part, although gold missed out on the uptrend in March.
(click to enlarge. source: Google Finance)
If the markets see a significant rally into year end, I believe gold might get a lift as well. If the recent downturn extends, however, gold might continue to fall until it hits the next major support level.
Conclusion: Play The Waiting Game
Despite these short to medium term cautionary factors, I think the long-term future for gold is still bright and shiny. If I currently held gold, I wouldn't see any reason to liquidate a major portion of my holdings. However, since gold really could go either way for the rest of the summer, I'm going to refrain from initiating a long position until the markets provide more direction to confirm whether the recent downturn was simply temporary or indicative of a longer-term pullback. In either case, I'll be looking for an attractive entry point into GLD. Those with a little more of a paranoid streak might also want follow the price action of the Sprott Physical Gold Trust (PHYS) to look for a low-premium entry opportunity.
Disclosure: I am long SLV.