China Threat Not Enough To Boost Gold Demand

Includes: FXY, IAU, UUP
by: Clif Droke

Tariff increase on Chinese goods not enough to justify gold rally.

Only a threat to U.S. economy, or the dollar's strength, will suffice.

Foreign currency strength suggests dollar pullback may be imminent.

Gold investors in the last two months have been vigilant in their search for the next rally catalyst. The breakdown in the dollar index which many had hoped for has failed to materialize, and the U.S. equity bull market remains firmly intact which has reduced safety demand for gold. Meanwhile, many gold bugs believe the latest setback in the trade negotiations between the U.S. and China offers the metal its best opportunity to rally since February.

In today's report, however, I'll show that the threat of a trade war escalation by itself isn't enough to spark a renewed rally phase for gold. I'll also argue that what's needed to spark safe-haven interest in gold is a serious threat to the U.S. stock market or economy, along with sustained weakness in the dollar. And while this weakness hasn't manifested yet, there are signs that a dollar index pullback may soon occur.

Equity investors were clearly blindsided by President Trump's latest tweet that he plans to increase tariffs on Chinese goods. This much was made clearly by the comprehensive equity market decline to start the week. But while many observers believe the latest escalation of the trade war is bad news for U.S. equities, the stock market's resilience in bouncing back on Monday undermined that belief. What's more, there was no evidence of below-the-surface selling pressure as the number of stocks making new 52-week lows on both major exchanges remained below normal.

The U.S. stock market's resilience was surely a disappointment to gold investors who are looking for anything that will increase gold's safe-haven demand right now. With the yellow metal still in a position of relative weakness versus the U.S. stock market (see chart below), gold investors will likely have to look elsewhere for the next "fear factor" increase that will boost gold demand.

Gold vs. S&P 500 Index Source: StockCharts

Many participants also expected that the gold price would have reacted more positively than it did to the latest trade war threat. Instead, the June gold futures price rose by a mere 0.08% on Monday, although it did manage to barely close above its 15-day moving average for the first time since April. However, the gold price must still contend with a significant amount of overhead supply from the selling of the last several weeks. Most of this supply appears to be concentrated between the $1,305 and $1,335 levels.

June 2019 Gold

Source: BigCharts

It should also be pointed out that the gold price remains under its widely watched, and therefore psychologically significant, 50-day moving average. This is signified by the blue line in the above chart. Until we see a weekly close above the 50-day MA, gold should be considered to be still in the hands of the sellers.

On the ETF front, the iShares Gold Trust (IAU) managed to close slightly above its 15-day moving average on May 6, but is still under the more widely watched 50-day MA. This confirms that IAU remains in the hands of the sellers. As I intimated in the previous report, however, a bottoming attempt could well be underway for the gold ETF given its recent resilience in the face of dollar-related weakness. That said, until the U.S. dollar index reverses its rising trend and shows decisive weakness, traders should remain in a cash position and wait for gold to decisively confirm a bottom.

iShares Gold Trust

Source: BigCharts

Speaking of the dollar, shown here is the Invesco DB U.S. Dollar Index Bullish Fund (UUP). Although the gold and the gold ETF have both managed a close above the 15-day MA, the dollar ETF hasn't yet closed under its 15-day MA. This tells me that the dollar's immediate-term (1-4 week) upward trend is still technically intact. More significantly from both a technical and a psychological standpoint, the dollar ETF remains above its rising 50-day moving average. As long as the dollar is in a bullish position, the gold price will remain vulnerable to currency-related headwinds.

Invesco DB U.S. Dollar Index Bullish Fund

Source: BigCharts

Along with a breakdown in the U.S. dollar's upward trend, another major factor which would argue in favor of a renewed gold rally would be anything which threatens the U.S. economic outlook. As long as the U.S. stock market ignores negative developments in the trade war with China, the U.S. will remain a top destination for foreign flight capital. This is clearly reflected in the U.S. dollar's strength, as well as the recent new highs in the S&P 500 Index (SPX). A far more likely catalyst for gold's next rally phase is a technical pullback in the U.S. dollar index, which has marched relentlessly higher since February. The recent bottoming attempt of the Japanese Yen, as shown in the Invesco CurrencyShares Japanese Yen Trust (FXY), as well as bottoming attempts in the euro currency, suggest that a dollar pullback could be imminent.

Invesco CurrencyShares Japanese Yen Trust

Source: BigCharts

Until the dollar has reversed its immediate-term upward trend, however, investors aren't justified in assuming that the gold price has bottomed. It must be emphasized that we need to see significant weakness in the dollar index, and until we do the yellow metal is likely to encounter strong headwinds. Accordingly, a defensive position is still warranted with no new long positions in either bullion or gold ETFs recommended.

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.