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What Now For Gold? Is It A Perfect Storm For The Precious Metal?

Gold bars
Gold bars

Gold is not as shiny as it once was, so IFA Magazine asked for an update from the Chief Market Strategist at CMC Markets Colin Cieszynski.

He sent us his latest report:

“Following two months of steady declines, the bottom has fallen out from under the price of gold this week. An initial loss of over $50 per ounce was trimmed back to $25 on Monday, but a lot of damage has been done.

There are a number of factors that are widely recognised as helping to drive the price of gold up and down, over both the short and long term. At the moment, several of these factors have turned against gold, creating a perfect storm that could lead to a retest of the big $1,000 level in the coming months.

1)       Reduced demand for defensive havens:

Gold has historically been seen as a store of value and a haven for capital in times of tension, at the moment however, the pendulum has swing back the other way.

With Greece passing austerity measures last week, receiving bridge financing to meet its immediate obligations and reopening its banks (although capital controls remain on and the Athens stock exchange remains closed) the risk of an imminent Grexit has passed for now. Negotiations on a third bailout package are about to get underway and with Germany hinting at the potential for debt relief over the weekend in exchange for more reforms, the crisis phase appears to be passing although it could return or something else could pop up down the road (there is the potential Greece could have another election this fall and Spain plus Portugal are already on the schedule for later this year).

Political tensions around the world also appear to be easing with the completion of the Iran nuclear deal and the US burying the hatchet reopening diplomatic relations with Cuba today.

Chinese markets continue to stabilize and fears about its economy have eased following last week’s better than expected GDP, industrial production and retail sales figures.

2)       Reduced need for inflation hedges

Gold as world’s premiere hard asset currency has historically been seen as a hedge against inflation.

With Iran preparing to return to the oil market amid an ongoing supply war among other producers including the US, Saudi Arabia, Iraq and Russia, the price of oil has tumbled back toward $50 for WTI and $56 for Brent. Because energy prices are a significant component of inflation measures, falling oil means that headline inflation looks likely to remain subdued for some time.

3)       US interest rate liftoff and USD rally

Gold is priced in USD and often trades in the opposite direction from the world’s premiere paper currency. The risk that financial crises in Europe and China could spiral out of control and upset the world economy has eased dramatically in the last week, keeping the Fed on course toward interest rate liftoff.

Last week, FOMC Chair Yellen indicated in testimony she still expects rate lift-off this year, while Monday morning St. Louis Fed President Bullard indicated he sees the odds for a September lift-off above 50%.

Increased prospects that the Fed may start raising interest rates as early as September has driven USD higher against many other currencies, including gold.

4)       China and gold purchases

One factor that gold bugs had been using this century to underpin their bullish outlook for gold had been that China’s PBOC has been buying gold and could potentially eventually make CNY a gold backed currency.

Last week, China announced it has increased its gold reserves by approximately 60% since 2009 to 1,658 tonnes. This would have been great for gold except that on a relative basis, gold still only represents about 1.5% of China’s forex reserves. Even worse than all of these purchases, gold’s weighting in the PBOC’s portfolio hasn’t grown in the last six years, pretty much crushing hopes China’s drive to a free floating currency would save the gold price.

Where could gold go from here? Technical and seasonal factors

Gold’s big selloff Monday has attracted a lot of attention, but the big drop and rebound raises questions as to whether this is the start of a new downleg or the final washout before a rebound.

The daily chart below shows Monday’s collapse confirmed a breakdown through of $1,142 that completed a bearish descending triangle pattern. The fall towards $1,175, however, has already reached the measured objective from its previous $1,140 to $1,220 trading range. With RSI getting oversold also suggests it may have fallen too far too fast and could be ready to consolidate.

cmcgraph1
Source: CMC Markets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The long-term monthly chart below shows that having tested $1,080, gold has now completed a 50% retracement of its 2001-2011 bull markets. This is the point where counter-trends have historically often been contained. Should that level drop, gold could fall to retest the $1,000 big round number or perhaps even complete a 62% retracement by testing $880 over time. If gold were to rebound, it could bounce back up towards the $1,160 to $1,240 range where it traded previously.

cmcgraph2
Source: CMC Markets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Finally, seasonality suggests that gold’s selloff may be close to running its course. Historically, May to July has been one of the weakest times of the year for gold, however it has then bounced back in August and September ahead of Wedding Season in India, the peak time of year for physical gold demand.

Average Monthly Return 1987-present:

Month Gold
January 0.12%
February 0.28%
March (0.15%)
April 1.04%
May 0.11%
June 0.04%
July 0.10%
August 0.83%
September 1.85%
October (0.13%)
November 2.05%
December 0.58%

Source: CMC Markets

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