Things That Shimmer Don't Always Shine

Summary

• The USD is dropping and gold is not back at last year's highs.
• Gold prices are affected by more than currency spot rates.
• Recent moves in gold, 10-yr yields and USD.
• How to play it.

The USD is dropping and gold is not back at last year’s highs.

The USD has been moving down for months now and gold and gold miners are not moving up, what gives? The last 8% drop in the USD pushed gold miners and gold spot prices up significantly. The USD has made the same move and comparatively prices have not moved as much as one would expect. The culprit, interest rates.

Gold prices are affected by more than currency spot rates.

Since gold trades as a quasi-currency, trading decisions are made on the perceived carry in relation to the USD. Currencies have a spot rate, or the real rate at which they are traded currently, as well as interest rates. As interest rates in a country increase, the spot price of the currency will tend to increase; these changes can be brought on by both central banking and market conditions.

Recent moves in gold, 10-yr yields and USD.

That said, during the last 8% drop in the USD, beginning at the end of 2015, interest rates on US Treasuries fell more than this last drop beginning at the end of 2016; the US 10-yr rates dropped approximately 43% and 20% respectively. This phenomenon muted the rise in gold prices because the shallower drop in rates shows that investors believe that rates will go up and the USD will bounce back, removing demand for gold investment products. Below are charts illustrating the differences in price movement:

You can plainly see that both gold and the 10-yr yield contracts experienced the same moves, the first being twice the amount the most recent, while the USD experienced the same size move both times. Now that you can see this in pictures, the conclusion that people are starting to have more confidence in total US recovery is apparent.

How to play it.

The fact that investors do see the US economy doing better and while the herd has reversed its USD positions for now, full conviction is not there. There is confidence starting to build that the United States Federal Reserve will live up to its recent promises, continue raising rates and allow assets to run off the balance sheet. To me, this says that this last gold rally will fail and that it should continue to move down over the coming months.

Here are some important levels for GC or gold futures; just under 1500, 1242, 1170, 1040 and 855:

The SPDR Gold Trust ETF (GLD) looks very similar to the gold futures, the first target I will shoot for here is 114, then 101. In GLD, I will be looking to put on a vertical spread for the first target of 114 and then start building a larger position targeting 101 as volatility increases. A good option for many traders on the further away target would be an iron condor or butterfly spread depending on how much volatility increases.

Let me just say this, the only way that gold is getting back to 1,500 anytime soon is if the US falls into a deep recession by way of black swan, China has a Minsky moment and collapses, the EU disintegrates abruptly or there is a world war with nukes and the whole nine. It is for these reasons that limited risk options plays make for safer trading in gold investment vehicles.

Analyst’s 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.