Just when it looked like gold would be stuck in a trendless trading band for weeks on end, a timely injection of renewed fears over interest rates and the U.S.-China trade war revived gold demand. In today’s report we’ll look at the variables which support a continued rising path for the metal, as gold now has a good chance of finally escaping its month-long trading range in August. We’ll also briefly discuss the continued strength in the gold mining stocks.
The Fed’s decision to cut its benchmark interest rate by a quarter of a point on July 30 was a good enough reason for investors to hold onto their long positions in the yellow metal. But what happened the day following that decision was all the confirmation that participants needed to let them know that gold’s fear-driven bull market hasn’t expired yet.
Last week’s gold rally was fueled partly by the prospect of lower interest rates, which lower the opportunity cost of holding non-yielding bullion. An even bigger stimulus for the latest gold rally, however, was falling stock prices. U.S. and global equity prices fell for five straight days last week as investors expressed their collective disappointment with the Fed’s tepid response to the market’s demand for lower interest rates. Although the Federal Reserve lowered its benchmark rate by a quarter percent – the first such rate cut in a decade – the move was deemed too conservative by many participants. A half-percentage rate cut would have been much more to the market’s liking and the Fed’s failure to answer the demands significantly lower rates was met with across-the-board selling of risk assets and a subsequent flight to safety.
Gold futures prices rose by 2% in the wake of the Fed’s rate decision after being confined to a lateral trading range for most of July. The gold continuous contract price closed at a yearly high of $1,452 on Aug. 2 after hitting a session high of $1,462. Silver prices were also up the day after the FOMC meeting after a temporary breach below the 15-day moving average. While silver did initially participate in a sympathy rally with gold, it has since lagged the metal and closed lower for the latest week. This suggests that gold will likely rally alone due to safety-seeking behavior among traders instead of broad-based precious metals demand.
Gold meanwhile is blazing its own path based primarily on the widespread uncertainty over the future state of the global economy. The fact that the continuous contract gold price (below) has steadfastly refused to close decisively under its 15-day moving average is a testament to the insatiable demand for the metal, bolstered by never-ending fear. We haven’t seen the end of gold’s intermediate-term (3-6 month) upward trend, especially now that investors have additional reasons to be afraid over the global economic outlook.
One of those reasons came in the form of a series of tweets by President Trump, who said the U.S. would impose a 10% tariff on $300 billion Chinese imports beginning in September. The response to the latest escalation in the U.S.-China trade war was categorical, as shares of both U.S. and Chinese companies were sold on the news. This also gave gold bulls an additional impetus for adding to their holdings in the metal, as evidenced by the latest breakout to higher levels. But while gold rose in response to the tariff threat, other commodities were negatively impacted by it – especially oil. The WTI crude oil price dropped almost 8% intraday Aug. 1 in what was the biggest 1-day loss in more than four years (see chart below). This underscored the biggest potential problem gold faces as it rallies virtually alone among the major commodities.
The problem I’m referring to is the continued strength in the U.S. dollar in which commodities are priced. While the Fed’s latest rate cuts were expected by some analysts to weaken the dollar, this hasn’t yet been the case. Instead, the U.S. dollar index (DXY) continues to push to new yearly highs as worried investors are running just as fast to the perceived safety of the greenback as they are to gold.
The continued push to higher levels in the dollar index is also putting downward pressure on commodity prices in several categories. Speaking of commodities, below is a 4-week rate of change oscillator for the new quarterly highs and lows of over 25 actively traded commodities. This indicator is how I measure the incremental demand for a broad spectrum of commodities. It’s also a reflection of the near-term path of least resistance for commodities as measured by the S&P GSCI Commodity Index, which was down nearly 3% on Aug. 1. This indicator is slumping and is making it easier for large speculators to push commodity prices lower in the wake of a stronger dollar.
Shown below is the Invesco DB Commodity Index Tracking Fund (DBC), which is another favorite measure of the overall broad market for commodities. As you can see, DBC is under serious pressure thanks to the rising dollar. Gold is one of the very few exceptions to weak commodity prices right now as the dollar continues to strength, putting pressure on hard asset prices.
What all of this means for gold is that the metal’s latest rally is primarily a fear-driven affair and isn’t based on broad demand for hard assets or a soft dollar. Fear is a fleeting emotion, however, and can reverse on a dime should investors receive assurance from Trump administration that the threatened tariffs against China won’t be implemented.
Additionally, any assurance from the Fed that it plans to further loosen its monetary policy would be welcome news to equity investors, in turn reducing the demand for safety-related gold purchases. So while gold still remains in the hands of the buyers right now, investors would do well to remember that gold’s latest rally can swiftly reverse in the event that the market’s “fear factor” diminishes. For this reason, I recommend that participants continue to raise stop loss levels on open long positions in gold as the price continues to rise.
Turning our attention to the gold mining stocks, there are enough strong gold miners right now to justify a continued bullish stance in the overall mining sector. This is illustrated by the following graph which shows the 4-week rate of change in the new highs and lows of the 50 most actively traded U.S.-listed gold stocks. As long as the dashed line in this chart remains intact, I consider the near-term path of least resistance for the mining shares to still be up.
On a related note, a recent Reuters poll found that analysts expect gold prices to maintain its recent gains and hold above $1,400 next year based on central bank demand and resurgent investor interest in the metal as a safety asset. According to Reuters:
Gold is expected to retain its gains but not rise much further, the poll of 33 analysts and traders showed. They returned a median forecast for prices to average $1,351 an ounce this year and $1,433 in 2020.”
The gold forecasts are “sharply higher than in a similar poll conducted three months ago,” said Reuters, while the predictions for silver have become significantly more pessimistic. Poll participants expressed the view that silver was unlikely to rally convincingly. Analysts are forecasting average silver prices of $15.50 for this year and $16.85 in 2020.
In summary, gold has received a new lease on its rally which technically began in May. The latest flare-up in worries pertaining to the state of global trade and the U.S. economy should suffice to keep bullion prices in a rising trend in August, as well as resulting in higher prices for gold mining stocks. However, due to the recent strength of the U.S. dollar and subsequent weakness in other commodities, investors should remain cautious and be aware that continued dollar strength could keep gold prices from making substantial gains in the near term. Accordingly, I recommend that investors hold off on initiating any new purchases in gold right now. However, existing longer-term positions in gold and gold ETFs can be retained along with intermediate-term (3-6 month) positions in gold mining stocks.
On a strategic note, I’m currently long gold via the VanEck Vectors Gold Miners ETF (GDX). For this ETF I’m using a level slightly under $26.00 as a stop-loss on an intraday basis. Participants who haven’t done so should also book some profit in GDX after its impressive run of the last few weeks.
Disclosure: I am/we are long GDX. 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.