Gold: Alas, It Isn't A Bottom Yet

Summary

• Inflation and interest rates determine the price of gold.
• Both of these factors are now negative for the gold market.
• Despite the recent fall in the price of gold, the potential for further decline still remains.

Investment Thesis

The analysis of the fundamental dependence of gold price on real interest rate allows drawing a conclusion that the negative market trend persists.

The dynamics of the real interest rate has been, and remains, a key factor shaping the long-term trend of gold price.

To be precise, judging by the value of the rolling correlation over the last 90 days, a 70% change in the price of gold was due to the change in the U.S. real interest rates. I will assume that this dependence will persist in the near future.

In other words, the formula is simple: the higher is the yield of the U.S. bonds and the lower is the inflation, the cheaper is gold, and vice a versa. Ironically, both of these factors are now playing against gold.

The U.S. macro statistics published in the last week cannot be defined as "positive". In May, personal consumer income rose by 0.4% YOY (higher than the expected + 0.3% YOY) continuing the positive trend of the previous two months.

But it was not a stimulus for growth in consumer spending. In May, this indicator rose by only 0,1% YOY as compared to 0,4% YOY in April.

This is explained by the fact that the income is growing not due to the increased wages, but due to the additional sources of revenue, for example, rents. Generally, this kind of income goes into saving, rather than consumption. As a result, in May, the U.S. inflation was falling for the fourth consecutive month, despite the fact that the economy is close to full employment.

On the other hand, over the past five trading sessions, the UST-10 yield increased by 21 bp, however, the investors still do not expect the U.S. interested rate to be increased more than once before the end of the year (probability - 50.6%). In my opinion, this indicates the fundamental nature of rising interest rates in the United States, and it cannot change quickly.

Source: CME group

As we can see, the real rate is increasing due to the simultaneous decrease of inflation and rising interest rates which is a very, very negative background for gold.

Additionally, the situation is worsened by the fact that gold is already overpriced relative to the current level of the real interest rate.

According to the linear model of dependency of the gold price on the level of the real interest rate, the current, balanced gold price is at least $60 lower than the actual level:

It is important that, according to my model, the current deviation of actual gold prices from its balanced level exceeds the boundaries of the standard deviation and corresponds to the maximum value of the deviation range:

The dynamics of deviations of the actual gold price from its predicted value is also interesting. Assuming that the cyclic nature of the deviations of the actual gold price from the balanced level (according to the model) continues, the price of gold is now at the beginning of the new, downward cycle:

It is noteworthy that the money managers operate fully appropriate to the situation, and from this point of view, the future prospects for gold are also not encouraging.

According to the COT reports, for the last three weeks, the money managers have reduced their long position in gold by more than 50%.

And, despite this, if we forecast gold price based on the size of the net money managers’ position, we again will come to the conclusion that gold is currently overpriced:

Putting It All Together

All the above analysis leads me to believe that gold price decrease process observed since early June, is far from completion.

Applying the foregoing to the dynamics of the SPDR Gold Shares ETF Fund (NYSEARCA:NYSEARCA:GLD) (a fund that tracks the price of gold) I expect the fund price to reduce to $112 in the next 40 days.

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.