In the recent gold price action, the falling knife is not a cliché - it's reality. Worst fears of gold bugs materialized: dollar rallies, the U.S. market is in a risk-on mode and Fed promised more rate hikes. Let's look at the situation as we head into the year 2017.
The U.S. dollar (NYSE: UUP) broke to new highs and continues to rally. This is not great news for gold, as the dollar is in the territory which was uncharted for years and it's difficult to predict where it will meet resistance.
The Fed was clear in its evaluation of the economy and so more rate hikes are coming. It's not a secret that rate hikes will put pressure on gold which pays no interest - but to which extent? Gold correction has been very fast and at least some of the pressure from the rate hikes is already priced in.
I believe that the dollar will continue to go up and ultimately reach a landmark parity with euro (NYSE: FXE). From a psychological point of view, this development will be bearish for gold. Unfortunately, the problems for gold are not limited to the strength of the U.S. dollar.
I continue to believe that the rising U.S. stock market together with rising oil prices are negative for gold. I mentioned this argument in one of my earlier articles on this subject and it was met with criticism - long-term observations do not confirm the link between the strength of the U.S. stock market and gold's weakness.
Nevertheless, I reiterate this argument as I believe that short-term correlation may exist (and be strong) regardless of longer-term trends.
The rally of the U.S. stock market is a major risk-on bet, especially if we don't forget that before the recent breakout to new highs the stock market was already quite pricey. The stock market rally together with oil rally after OPEC deal sucks money out of gold. The moment stocks and oil reach their ceiling will be the pivot point for gold.
I must admit that gold continues to look weak. There were no attempts to rebound after the major support level around $1225 per ounce was breached.
On the positive side, gold is near what I believe will be a good support level near $1100 per ounce. I think that gold has chances to get there, "helped" by the continuous rally in the U.S. dollar and U.S. stocks.
The simultaneous party for both the U.S. dollar and U.S. stocks cannot last forever. When we head back to our desks after winter holidays and look at the results of the earnings season, we would most likely see that multinationals' profits are under pressure due to the strong dollar.
I fail to see how this pressure could be mitigated to the point where it will not be evident in the results. In this case, one of the two scenarios must happen - either the U.S. dollar will stop appreciating or the U.S. stock market will correct from highs. Both events will be positive for gold.
At this point, I think that the stock market correction is more plausible than the U.S. dollar correction. The difference between the Fed policy and its peers in other parts of the world is too big to be ignored.
In my view, the next opportunity to initiate long positions in gold and gold miners will show up in the beginning of 2017. In comparison with the previous support at $1225, gold will reach the support at $1100 after a long period of downside, which greatly increases chances of rebound from this level.
Also, the significant decline in gold's price should increase physical demand for gold. I expect that this will show up in Q4 numbers and in Q1 2017 numbers as well if gold stays at current levels for a while.
All in all, I now expect a bit more downside for gold due to the simultaneous rally in the U.S. dollar and the U.S. stock market, but I believe that this process will reverse in 2017 and present a buying opportunity.
Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.