Commodities/Forex

Andy Hecht

Top 3 Ranking in Commodities, Metals & FX --SeekingAlpha

The Dollar And Gold

  • Gold has been in a bull market this century
  • Technical metrics point to a period of consolidation
  • Falling interest rates are bullish
  • The trade war is bullish
  • The dollar index may not support gold, but its price action in all currencies present a different picture

The dollar is the world’s reserve currency. Central banks all over the world hold dollar as a reserve asset because of the economic and political stability of the United States compared to other nations around the globe. The dollar has long been the king of the currency market. 

Meanwhile, central banks, monetary authorities, and governments hold gold as a reserve asset. The International Monetary Fund reports gold holdings each month as part of a country’s foreign exchange holdings. Over recent years, central banks have been net buyers of the yellow metal with China and Russia leading the way. Both nations are significant gold producers, and they have been accumulating domestic output to build their respective reserves. At the same time, both the Chinese and Russians have been buyers of gold in the international bullion market. 

While the dollar may still be the king of currencies, gold remains the monarch of money. Gold has been around as a means for exchange for thousands of years. The yellow metal has been a currency long before the dollar existed. Governments can print currencies to their heart’s content to stimulate economies. However, the supply of gold is finite and limited to above-ground stocks and the rate that producers can extract the metal from the crust of the earth. 

The dollar and gold have an inverse history. A strong dollar had tended to weigh on the price of gold while a weaker dollar had been supportive of the price of the precious metal. These days, both the dollar and gold are exhibiting price strength, which could be a commentary on the overall value of foreign exchange instruments around the world. 

Gold has been in a bull market this century

After moving from $1266 in April to a high at $1559.80 or 23.2%, gold settled into a trading range with $1500 the pivot point. 

Source: CQG

The long-term monthly chart highlights that gold had traded in a $331.30 range for half a decade from 2014 through 2019. The late 2015 low at $1046.20 and the July 2016 peak at $1377.50 defined the trading band. 

In June 2019, the price rose above the top end of the range and the level of technical resistance. In early September, the rally ran out of steam at $1559.80 per ounce, the highest price since 2013. 

Source: CQG

The quarterly chart illustrates that gold fell to a low of $252.50 per ounce in 1999. The precious metal made a marginally higher low in 2001 at $255. After a period of consolidation, gold broke out above the $400 level in 2003 and never looked back. 

Gold had traded to a high at $875 in 1980, and in 2008 it rose above that level. After a pullback to $681 following the global financial crisis in 2008, when the prices of all assets fell, the yellow metal exploded to the upside. Gold traded to its record high in dollar terms at $1920.70 in 2011. 

The correction that followed took the price to the late 2015 low. The move in June was the next leg in a bull market in gold that began way back at the turn of this century. 

Technical metrics point to a period of consolidation

Since early September, the gold futures market declined from $1559.80 to a low at $1458.30 per ounce. Gold dropped by just over $100 per ounce during the correction. However, since the level of long-term resistance at $1377.50 became technical support, it remained $80.80 above the breakout level. 

The recent correction is a healthy event for the gold market as it gives the yellow metal time to digest the latest move. 

Source: CQG

The weekly chart shows that price momentum and relative strength metrics have declined from overbought territory over the past weeks. They are gently falling towards a neutral condition, which has knocked some of the overenthusiasm out of the market. Meanwhile, open interest has been flatlining, telling us that the price correction has not deterred buyers. The rise in the number of open long and short positions in the COMEX gold futures market since April is a technical validation of the bull market trend. The metric moved from 429,551 contracts during the week of April 22 to an all-time peak at 658,944 in late September and was at around the 615,000-contract level at the end of last week.  While some of the weaker longs have exited risk positions, the lower price is attracting new buyers as gold consolidates. 

Weekly historical volatility rose to a high at 19.60% in early September, but the metric was at 12.28% on Friday, October 11. 

The technical picture for gold remains bullish on medium and long-term charts. Moreover, fundamentals continue to favor higher prices. 

Falling interest rates are bullish

The US Federal Reserve lit the bullish fuse under the gold market in June when it told markets it would reduce short-term rates. On July 31, the FOMC moved to cut the Fed Funds rate by 25 basis points for the first time in years. At the same time, the central bank ended its balance sheet normalization program that had been pushing rates up further out along the yield curve. On September 18, the Fed cut rates by 25 basis points once again. As of the end of last week, the markets were expecting another two rate cuts before the end of 2019 that would total a full percentage point for this year. In 2018 the Fed hiked rates by that much, so if the market is correct, the move will erase last year’s hawkish moves. 

Rates are not only falling in the US these days. China has slashed interest rates to stimulate its economy in the face of the trade war. At the same time, the European Central Bank cut its deposit rate by ten basis points to negative 50 basis points at its September meeting. Lower rates around the world make the cost of carrying a long position in gold less expensive. Moreover, a falling rate environment makes gold more attractive compared to fixed-income investment vehicles. Lower rates are bullish for the price of gold. 

The trade war is bullish

One of the signs of just how sensitive the gold price is to the ongoing trade war between the US and China was the price action following the July 31 FOMC meeting. The market was disappointed when the Fed only cut rates by 25 basis points as many participants had expected a 50-basis point reduction. 

Source: CQG

The daily chart of December gold futures shows that on July 31, gold closed at $1426.10 per ounce and only traded to a high at $1447.80 during the session. On the following day, it fell to $1412.10 as the market digested the Fed’s interest rate cut. Meanwhile, August 1 was the day that US President Trump decided to slap a new round of tariffs on China after he became frustrated with the negotiating process. The escalation of the trade war and Chinese retaliation in early August lifted the price of gold and sent it to the early September high.

Last week, Chinese and US negotiators met in Washington DC to find common ground on an agreement that would end the trade war. However, the gulf between the two sides remains wide. Even though the two sides announced a phase one agreement on Friday, there is a long way to go before a comprehensive trade deal will settle the issue.

The fear and uncertainty surrounding the rising potential for a global recession have fueled the rally in gold. A return of pessimism over trade could once again ignite the gold market over the coming weeks. Meanwhile, trade is not the only issue that could cause the kind of fear and uncertainty that would send a herd of buyers back into the gold market these days. Iran continues to be a problem in the Middle East. Brexit is a problem for the UK and Europe. And, the US House of Representatives has begun the impeachment process to remove President Trump from office just as the 2020 election is kicking into high gear. The global political and economic landscapes present a potent bullish cocktail for safe-haven assets like gold. 

The dollar index may not support gold, but its price action in all currencies present a different picture

Gold has proven that it is the monarch of money over the recent months. The price moved higher by over 23% in US dollar terms at a time when the dollar index was moving higher. 

Source: CQG

As the weekly chart highlights, the dollar index hit a higher low at 95.365 in late June when gold was breaking out to the upside. However, the dollar index rallied to a high at 99.33 in early September when gold was just shy of the $1560 level. The historical relationship between the dollar and gold diverged over the summer months leading to extraordinary gains for the yellow metal in other currency terms. 

Source: CQG

The monthly chart shows that gold in euro terms rose to a new record high in September on the back of strength in both the dollar and the gold market. The euro was not the first to move to a record level. The yen, pound, Australian dollar, Canadian dollar, Chinese yuan, Russian ruble, and a host of other currencies all experienced new record levels for the yellow metal over the past months. 

On the high in early September, gold remained $360.90 or just over 23% below its record high from 2011. The other currency that did achieve a record against gold was the Swiss franc. 

Source: CQG

The chart of gold in Swiss franc terms shows that at 1469.90 at the end of last week, it was 192.61 francs or 13.1% below a record level.

The bottom line is that gold has been rallying in all currencies since the turn of this century, and the US dollar and Swiss franc are no exceptions. The recent correction and current period of consolidation is a healthy sign for the gold market. The correction could send prices temporarily lower in the short-term. However, the odds continue to favor higher highs and an ultimate challenge of the 2011 high in dollar terms and the $2000 per ounce level sooner, rather than later. 

The dollar will continue to be the king of currencies, but gold has a long history as the monarch of money, and that is not changing any time soon. 

Andy Hecht covers Commodities and Forex as one of the original contributing analysts at FATRADER. A former senior trader at one of the world’s leading commodities trading houses, Philipp Brothers (now part of Citigroup), Andy has worked and consulted for banks, hedge funds, and commodities producers and consumers around the world for over 35 years.
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