So far, 2018 has been a year of consolidation in the gold market. After two consecutive years of higher lows that began with a bottom at $1046.20 per ounce in December 2015, the price action in gold has gone to sleep over recent weeks and is flatlining around the $1300 per ounce level.
As the weekly chart highlights, the pattern of lower highs remains intact, but the upward bias in the gold market has shifted to a long period of price consolidation. In 2018, nearby COMEX gold futures have traded in a range from $1281.20 to $1365.40. The band of $84.20 per ounce is the tightest in years. In 2017, the range was $212, and in 2016 it was $316.50 per ounce. Gold has gone to sleep, and open interest has declined to around the 447,000 contract level on COMEX futures as market participants have become frustrated with the lack of volatility. Weekly historical price variance has declined to 6.25%, a reflection of the tight trading range so far this year. Meanwhile, price momentum on the weekly pictorial has dropped into oversold territory.
Gold's lack of direction could be a case of all quiet before the storm, as the yellow metal remains the oldest currency instrument in the world and a store of value for central banks and individual investors all over the earth. Central banks hold over 18 percent of all of the gold ever mined in history which is a significant part of government's foreign exchange reserves. I continue to believe the medium and long-term prospects for the yellow metal are bullish. Eventually, economics or politics will cause the price of get back on its bullish path which remains intact since the December 2015 lows.
A dip into the Fed meeting, as usual
The U.S. Federal Reserve began increasing the short-term Fed Funds rate in December 2015 when gold traded to its most recent significant bottom. The yellow metal has developed a habit of moving lower into FOMC meetings where the central bank moves to increase the short-term rate by 25 basis points and then rallying following the move. The old saying, "sell the rumor and buy the fact" has been an almost picture perfect characterization of the price action in the gold futures market. During the final months of 2015, 2016, and 2017, gold made significant lows perhaps because in each of those months the U.S. central bank moved to hike rates by one-quarter of one percent. The Fed will act to increase the rate for the seventh time since liftoff from zero on Wednesday, June 13 and the latest weakness in gold and its lifeless price activity around the $1300 level could be a repeat performance from the previous six rate hikes. Time will tell if we get a relief rally following the June FOMC meeting, but the downside trajectory of the yellow metal has not been severe leading into the central bank's meeting.
I believe four factors can move the price of gold higher over coming weeks and months. Each of the issues alone could be enough to trigger a rally, but a combination of events could cause the yellow metal to finally surpass the $1400 level which we have not seen since 2013.
Inflationary pressures - copper
Following the global financial crisis in 2008, the leading central banks of the world dug deep into their monetary policy toolboxes to come up with strategies to avoid recession by encouraging borrowing and spending and inhibiting borrowing. The U.S. Fed led the way, slashing the Fed Fund rate to zero percent and instituting a program of quantitative easing. QE installed a put option under the government bond market to keep rates at artificially low levels further out on the yield curve. While the program came to an end in 2014 and 2015 and rates began to rise, massive amounts of liquidity from the U.S. central bank flooded the markets during the accommodative period. The European Central Bank followed the Fed into accommodation but has yet to follow them out. Short-term rates in Europe remain at the negative forty basis point level, and QE in Europe continues to have a put option in place on not only government debt issues, but some high-quality corporate issues. In Japan, short-term rates remain in negative territory. We will hear from the ECB on Thursday, and the BOJ on Friday when it comes to their programs and whether they will signal any shift from monetary policy accommodation.
The dovish central bank programs created unprecedented amounts of liquidity in markets and we have seen some mixed results in markets. In the U.S. the Fed upgraded economic growth from "moderate" to "solid" last year. QE has shifted to QT as former asset purchases are rolling off the central bank's balance sheet on a monthly basis. Fiscal stimulus in the form of a tax reform package has added a shot in the arm to the U.S. economy where GDP is now growing at around the 3 percent level. In Europe, growth remains lethargic with the latest reading at 0.4% and Japan continues to suffer from an aging workforce, higher costs of an older population, and declining productivity. However, the central banks have set their target for inflation at the 2 percent level, and it appears that the economic condition has reached that level. At their May meeting, the Fed told markets they would take a "symmetric" approach to inflation meaning they may allow the environment that eats away at the value of money to rise above their target level for a period to allow for economic growth.
There are many signs of inflation in the U.S. and global economies at this time. The price of crude oil, the ubiquitous energy commodity, is appreciably higher this June than it was last year at this time. Doctor Copper, the industrial metal that tends to diagnose the health of the global economy is currently flirting with its December 2017peak at $3.3220 per pound.
As the weekly chart illustrates, the price of the red metal rose to a high of $3.3155 last week, which was only 0.65 cents below the December 2017 peak and the level of critical technical resistance for copper. Copper has been trading in a bullish trend making higher lows and higher highs since January 2016 when it found a bottom at $1.9355 per pound. Copper is close to its highest price since early 2014.
Inflation tends to be a highly supportive factor for the price of gold. A continuation of the pattern of increasing pressures could lift the price of the yellow metal that is a barometer of the economic condition. The price for a decade of dovish monetary policy is likely to cause inflationary pressures to remain a significant threat to the global economy.
Increase volatility in asset prices
The stock market had been on a one-way trip to the upside since early 2016 when a six-week correction took the S&P 500 11.5% lower. However, the wild bullish ride that resulted in almost daily record highs throughout 2017 and into early 2018 came to an end when medium and longer-term interest rates began to rise. Stocks compete for investment capital with fixed income products, and the increase in yields caused a sharp correction in early February 2018. Corporate earnings have been strong as a result of corporate tax reform, and the indexes have come back from lows. In the case of technology equities, they moved to new highs over recent days and weeks. However, the path of least resistance for rates remains higher, and that could cause lots of price variance in the stock market over the second half of 2018.
As the chart of the U.S. 30-year long bond shows, the price made a high in July 2016 and has been trending lower since that peak. Interest rates have been rising from historically low levels across the yield curve, and more pressure on bonds could cause another round of turbulence in the stock market. Meanwhile, earnings will likely support lofty levels for equities, but as bond yields rise above the dividend yield of many stocks, we could see another sharp correction in the equity market. While higher interest rates increase the cost of carrying both long positions and inventories in commodities and can weigh on prices, higher rates because of inflationary pressures are likely to have the opposite effect. The bottom line is that increased volatility in stock and bond markets could cause demand for gold to rise and lift the price of the yellow metal.
The ongoing trade saga
To fulfill his promises to level the playing field in international trade, President Donald Trump has rolled out tariffs as a weapon to renegotiate existing trade agreements with partners around the world to achieve "reciprocity and fairness." Tariffs tend to distort commodities prices and can cause periods of volatility in markets across all asset classes. The potential for a trade war increased over the past weekend as the President took on members of the G-7 and refused to sign the declaration because of comments by the Canadian Prime Minister. Trading partners around the world have objected to the President's desire to negotiate on a bilateral rather than multilateral basis and achieve "better deals" than past administrations for the current balance of trade in the world. When it comes to the tariffs issue, the President has put the world on notice with tariffs on trading partners around the world including those in North America, Europe, and China. In response, retaliation has it U.S. agricultural producers, and it is possible that the current tit-for-tat environment will lead to a trade war which will distort prices around the world.
Since the U.S. is at the center of the trade issues, it is possible that the recent correction in the dollar could end and the greenback could fall under the weight of protectionist policies. Moreover, the dollar could become a trade weapon for the Trump Administration as a weaker dollar makes U.S. exports more attractive in global markets.
As the weekly chart of the dollar index futures contract shows, the correction in the greenback took it to a high at 94.975 in late May, but it is starting to look like the upside trajectory is running out of steam. The critical technical resistance level for the index stands at the November 2017 peak at 95.07, and the greenback failed before a challenge of that level. A failure in the dollar index and escalating trade tensions could set the stage for a rally in the price of gold. A weaker dollar is typically bullish for the yellow metal, and the trade situation increases fear and uncertainty in markets across all asset classes.
Finally, the world remains a volatile place filled with the potential for geopolitical events that could lead many market participants to the gold market for safety and wealth preservation. While this week's peace summit between the U.S. President and North Korean leader Kim Jong Un has lowered the temperature on the Korean Peninsula and could lead to lasting peace, there is no guaranty that the hermit nation will give up its nuclear weapons. President Trump has made it clear that without total and verifiable denuclearization, the U.S. will be left with few choices but a dangerous military option to address the situation.
Meanwhile, the Middle East promises to continue to be a problematic region. The decertification of the Iran nuclear nonproliferation agreement and ongoing proxy war between the Saudis and Iranians could cause sudden flare-ups in hostilities in the region which would translate to fear and uncertainty in markets across all asset classes. At the same time, China's expansionary desires in the South China Sea and continued Russian provocations under Vladimir Putin increase the potential for events that would surprise markets and cause a flight to safe-haven assets, like gold.
On the domestic U.S. front, while the President would be a candidate for a Nobel Prize for his work with North Korea, members of the opposing political party and a special prosecutor continue to threaten to undermine his administration. The mid-term elections in November will either support or frustrate his ability to continue with his agenda when it comes to legislative support.
There are so many issues facing markets that could propel the price of gold to the upside over coming weeks and months. When, and if, gold finally decides to move to a new level on the upside, gold mining stocks will likely outperform the price action in the yellow metal. During bull markets, gold mining shares tend to rise more than the price of gold on a percentage basis.
Like gold, action in the GDX gold mining index has been flatlining over recent weeks. The GDX has traded from $20.84 to $24.86 so far this year and was at the $22.45 per share level on Tuesday, June 12, close to the middle of its trading range. If gold decides to take off to the upside and climb above the $1400 level, it is likely that the GDX will do even better on a percentage basis.
There are a handful of factors that could cause the price of gold to move away from its current narrow trading range in 2018 and make strides on the upside. Gold is the world's oldest currency and the metal has a long history as a store of value. Gold may just be resting before making its next move, and the upside still looks like the path of least resistance for the precious metal.
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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.
Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.