- Gold's main driver, fear, is a double-sided coin.
- Gold's price can suffer during stock market declines, but not for long.
- Latest bout of global market jitters paves the way for next gold rally.
It's widely known among gold investors that one of the metal's biggest drivers is safety-related demand among investors who worry about the outlook for equities or the economy. Indeed, we've witnessed numerous instances of the "fear factor" pushing gold prices higher in the nine years following the credit crash.
Yet there's another side of this proverbial coin which bears discussion, namely the fact that gold also tends to fall in sympathy with stocks during periods of major equity market weakness. In this commentary I'll explain the seeming paradox of why gold is both a potential buyer's risk during panicky markets as well as a smart safety bet during periods of investor uncertainty. I'll also show that once the immediate selling pressure which has plagued the market this week lifts, gold should benefit from it even more than global equities.
Gold prices were steady on Wednesday after the previous session's 1% drop following market's concerns that the Federal Reserve would raise rates four times this year rather than the previously expected three. Meanwhile the U.S. dollar index hit a five-week high, buoyed by Fed Chairman Powell's optimistic assessment of the U.S. economy during this week's Congressional testimony.
Spot gold was essentially unchanged at $1,317 on Wednesday after finishing around 2 percent lower for the month of February. April gold futures settled $1 lower on Wednesday at $1,318. Although gold prices held steady for the day, the rising dollar index is keeping the pressure on gold and preventing the metal from breaking away from its 6-week lateral range.
From an immediate-term (1-4 week) perspective, one of the most important considerations besides the strength of the dollar is the relationship of gold's price to its 15-day moving average. This indicator is used to delineate not only the direction of gold's immediate trend but also its strength, which is reflected by the slope of the moving average. As can be seen in Wednesday's chart of the iShares Gold Trust (IAU), my favorite gold proxy, the price line remains under the downward-sloping 15-day MA while the price is barely hanging above its Feb.7 pivotal low of $12.62. As long as IAU remains under this trend line I don't recommend that participants initiate any new long positions as further improvement is required for gold.
Meanwhile the lack of immediate-term price velocity in IAU is reflected in the 12-day momentum indicator shown in the above graph. IAU's immediate-term momentum is essentially non-existent right now. This is another reason for waiting for the market to signal that it has fully regained the internal strength which was sapped by the recent actions in the dollar index.
Speaking of the dollar, the PowerShares DB US Dollar Index Bullish Fund (UUP) is nearly the reverse picture of gold's recent struggles. While the gold and gold ETF prices have fallen below the 15-day moving average, UUP has rallied above its 15-day MA and is threatening to break away from its 6-week potential bottoming pattern (below). The weakness in the global equity market of the last two days has helped to strengthen the demand for dollars are nervous investors liquidate stocks in rate-sensitive market sectors.
Yet another sign of how nervous investors have become this week can be seen in the following chart exhibit showing the iShares China Large-Cap ETF (FXI), which I use as a proxy for China's stock market. Global stocks tumbled Wednesday as disappointing Chinese and Japanese manufacturing and industrial output data fostered a bearish tone among investors. China's stock market is important for more than one reason since it not infrequently trends in line with the gold price. The reason is obvious: China is a major consumer of gold and the yellow metal's fortunes tend to wax and wane in response to the strength or weakness of China's industrial economy. Here you can see the China ETF FXI has sold off sharply in the last two sessions and is threatening to test Feb. 8 low at the $46.00 level. The last time FXI plumbed these depths in early February, the gold price moved in sympathy with it albeit not to the same degree of weakness.
If global equity market weakness continues in the days ahead, the playbook which gold normally follows in such cases is likely to repeat. That is, gold often declines along with the stock market on an immediate basis, then returns back in favor among investors seeking safety once the initial scare of falling equity prices has abated. This is what happened in microcosm during the stock market's early February plunge when gold briefly declined, then snapped back quickly by mid-month to its January high. The latest increase in global market selling pressure may in fact be the main reason behind gold's latest failure to continue its latest rally. In any case, high levels of investor fear are typically bullish for gold's intermediate-term outlook. Once the internal selling pressure which now plagues the global stock market dissipates, investors should look for the gold price to turn up once again.
In view of the above mentioned considerations, I recommend that conservative traders keep their powder dry and wait for the gold price to decisively strengthen before initiating any new trading positions. Longer-term investment positions in gold, however, can be maintained as the fundamentals underscoring gold's two-year recovery effort are still favorable.
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