Home' Australian Resources and Investment : June 2019 Contents I
n this report, I’ll discuss gold’s ongoing tussle with the US Federal
Reserve (the Fed) and the US dollar, as it fights for stability in the
wake of near-term market gyrations.
Let’s look at the performance of gold over the past three years, as I
believe it’s quite instructive of the metal’s resilience. Gold has traded
as high as $1344 on the COMEX futures contract so far in 2019 after
hitting a 2018 high of $1365. Last year’s peak created a double top in
the gold futures market, as the price hit the same high during January
and April. If we look back to 2017, gold reached a peak of $1358, while
a year earlier in 2016, gold peaked at $1377.50.
What this tells us is that there is a lot of congestion in the gold
market in terms of price between the $1340 and $1380 levels, with
each attempt to make a new high just falling short.
Despite this, what is significant is that gold continues to move
higher w ith respect to all of the leading currencies. This is reflected in
the long-term charts of gold in the dollar, euro and yen terms, which
all indicate bullish price trends.
While gold has failed to rise above the $1380 level, it has
demonstrated resilience, which is a sign of underlying demand. Gold
has been in a consolidation pattern, and it may be only a matter of
time before it finally builds the energy to move appreciably higher
and breaks to the upside on a technical basis.
As Figure 1 shows, gold has weakened below $1300 in the aftermath
of the release of the minutes from the most recent Federal Open Market
Committee (FOMC) meeting. Both price momentum and relative
strength metrics have declined to the lower area of neutral territory.
As a reminder, the Fed at its FOMC meeting cancelled its
projections for increases in the Fed Funds rate in 2019, and reduced
next year’s outlook to only one 25 basis point increase in 2020. At
the same time, the central bank announced that it would end its
Balance Sheet Normalization program, which had supported the
price of gold.
After the most recent FOMC meeting, market sentiment shifted
to expectations for a rate cut as the next move by the central bank;
however, this notion was dispelled when the latest Fed minutes had
no mention of any support for a decline in rates on the immediate
horizon, which led to an increase in interest rates and a drop in the
price of gold below $1300.
President Trump and members of his administration have been
highly critical of Fed Chairman Jerome Powell and members of the
FOMC due to their hawkish approach to monetary policy in 2018.
On more than one occasion, the President has lamented that rate
hikes and quantitative tightening have worked contrary to tax and
regulatory reforms when it comes to economic growth.
Recently, the President nominated Stephen Moore to the Fed,
and Moore has advocated for an immediate 50 basis point cut in the
Fed Funds rate. Larr y Kudlow, the administration’s Chief Economic
Adviser, echoed Moore’s call for a lower Fed Funds rate to undo the
damage done to the economy during 2018.
On a short-term basis, higher rates that are not the result of
inflationary pressures tend to be toxic for the price of gold.
Higher interest rates do not favour the upside in the gold market
for two reasons. Firstly, higher rates cause the cost of carr ying a long
position in gold to move higher. Like other assets, gold competes
with bonds for investment capital. As the yield on fixed-income
instruments increases, gold’s appeal tends to decline. Central banks
around the world hold vast quantities of the yellow metal as part
of their foreign currency reser ves – therefore, there are no supply
shortages in the gold market.
As such, higher interest rates lead to a higher contango in the gold
market, which means that the differential between prices for nearby
and deferred deliver y rises as interest rates move to the upside. When it
costs more to roll or carr y a long position in the yellow metal, it tends to
cause selling or a lack of buying that would take the price higher.
The second reason is that rising rates in the US increases the
yield differential between the US dollar and other world currencies,
causing the path of least resistance for the greenback to be higher.
The longstanding inverse price relationship between gold and the
dollar means that strength in the US currency typically translates to
weakness in the price of gold.
On a short-term basis,
higher rates that are not
the result of inflationary
pressures tend to be toxic for
the price of gold
AUSTRALIAN RESOURCES & INVESTMENT
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