Gold - is there a chance for a break out of trading range?

Summary:
- Gold prices move back from the important technical level of $1350/1370
- US dollar and bond yields remains key drivers for gold
- Investment demand could also be noteworthy
- SP500/gold ratio remains in a key place, there is still some space to the extreme levels though

Technical analysis

Gold prices rebounded sharply from $1150 in mid-August last year. Note that this move is continued in the first quarter of 2019. The rebound could be tied to broad-based weakness of the US dollar in response to lowered odds for higher rates in the US. Let’s take a closer look at gold price movements seen recently.

Gold prices fell in 2013 and 2014 in response to incoming tighter monetary policy in the world’s largest economy. Since the Fed has delivered its possible last rate hike we have seen that gold prices have formed a consolidation. Its upper limit is a range between $1350 and $1370. Note that the price responded to these levels in 2013 and 2014 and then in 2016-2018. The lower bound of the channel could be found between $1150 and $1200. The lowest level between 2013 and 2019 was around $1050 (reached in December 2015). Taking into account these time frames one may suspect that gold prices could be in a position to break above the resistance. On the other hand, gold prices look overbought when we take a look at the RSI oscillator.

Gold prices are again testing the upper bound of the consolidation. Source: xStation5

Fundamental situation seems to bode well for gold

Throughout the 2018 fundamentals did not support gold prices to say the least. Lower jewellery demand, decline in the investment demand and lacklustre performance of demand in general. Stronger USD can be named as a reason behind it as it prevent EM from buying more gold. Of course, changes in demand will to huge extent depend on the performance of the US currency. Nevertheless, supply side of the market balance hints at more price gains. According to WGC data and estimates from GFMS reports, it turns out that mine production dropped in 2018. Due to limited capital expenditures in the previous years there is a scope that output will fall further this year.

Gold mine production probably fell in 2018 and is expected to decline further in 2019. Source: WGC, GFMS, XTB Research

Investment demand seems to be another key factor for gold prices, especially demand from ETFs. Gold-backed ETFs began buying gold aggressively in the final quarter of 2018 what could have been one of the main factors behind rebound on the gold market. Moreover, investment demand rebounded the most significantly out of all gold demand sources. There were rumours that ETFs do not believe in the improvement of moods on the stock market and this is why they keep significant gold reserves. This trend has already reverted but according to ETF performance from the past 10 years, gold demand should continue to increase. Resumption of monetary tightening in the US can be seen as potential hurdle for this scenario to materialize.

Gold as safe haven asset

Gold does not look as a perfect investment right now. Why? Geopolitical tensions begin to ease and trade agreement between China and the US looks more and more probable. Brexit will probably be delayed and denuclearization of the Korean Peninsula is slowly progressing. In such a landscape safe haven assets like gold, JPY or CHF should have a hard time.

S&P500-to-gold ratio has increased recently to the levels last seen in 2007. In theory, S&P 500 seems to be overbought in comparison to really cheap gold. However, when we look at the turn of millenia (dot-com bubble) S&P 500 does not seem to be “too expensive”. On the other hand, we may experience consolidation of this ratio as it was the case in 60s and 70s. Source: Bloomberg

Rate hikes and 7-year USD cycle

Taking a look at the past behaviour of the US dollar one can see some kind of 7-year cycles of USD strengthening. The latest trough on the USD index occured around 7 years ago. However, as there is a risk that the US economy will experience a slowdown and Fed may have already paused rate hikes, there is some room for the USD to move lower. In such circumstances gold may be set to gain.

Taking into consideration time frames of previous USD rallies we should be within period of declines already. During the current cycle the US dollar index gained over 30% and we are close to the levels from which rebound started in 1990s. Moreover, USD is trading around 2 standard deviations away from the long-term mean just as it was the case back then. Having said that, we think that the 7-year cycle of the USD may be already coming to an end. Source: Bloomberg

Odds in favour and against higher interest rates at the end of 2019 are more or less equal now - in both cases around 0%. One can see that there was a significant correlation between gold price and expectations of the next monetary move in the past few months. However, in case odds will start to favour rate cuts we may see gold follow higher. Source: Bloomberg, XTB Research

Short-term view

In our analysis we have mention few factors that are determining current trend on the gold market. In our opinion performance of the USD amid next Fed move and behaviour of investment demand are equally important for gold. Prices may pull back over the short-term but such development would be inline with the current wave structure. It is possible that we will see a break above the important resistance zone ranging $1350-1370 but in order for it to happen we need either strong rebound in investment demand for gold or further underperformance of the US dollar.

Gold prices may fall over the short term but investment demand and USD weakening should support prices over the longer term. Source: xStation5