Gold Playbook – Gold will shine in EURs not USDs

An interesting conversation I’ve been debating with clients of late is why gold is failing to find any real love amid this backdrop of rising trade tension. Consider the tail risks of slower global growth, which we can see first-hand in the bull-trend in nominal and ‘real’ (or inflation-adjusted) bond yields.
Chris Weston

All the while we see $11.1t of global bonds now commanding a negative yield – the highest since January 2015 – and we could argue gold should be nicely above $1300 here.

As we can see though, gold has diverged from its link with both the pool of bonds that have a negative yield (red) and ‘real’ US 5-year Treasuries (green). At a simplistic level the idea, is that when the yield on offer in fixed income is falling sufficiently and going negative (reach out if you want more information on negative yields), then the fact gold has no yield is ironically yield in itself. Perhaps this is where we get this so-called ‘store of value’ mantra.

If we look at gold priced in USDs (XAUUSD), we can see strong support into $1270/66 and one suspects that if this gives way then we’d be looking for a move into $1250 to $1243. The series of lower highs seen since February suggests a cautious stance is warranted. That said, while I am neutral on price now, a close through $1287 would put a test of the top Bollinger band ($1297) in play and then the last major swing high of $1303.

Price is currently oscillating either side of the 20-day MA and is searching for direction. And, with the 14-day RSI sitting mid-range, the higher probability trade in the short-term here is to work orders into the wings of the Bollinger bands at $1297 to $1269 respectively in the short-term.

While we can look at potential levels that could accelerate price moves, or that we can identify as possible bid/supply zones. However, if we look at golds one-month implied vol, we can see this at a near record low and this shows that traders are simply not expecting big moves in price (in either direction). So, the market is portraying that this steady grind should continue, an important consideration for position sizing.

I talk about the technical set-up being neutral (at this juncture), but, in fact, we can see from gold futures positioning (taken from the weekly Commitment of Traders report), that managed money is about as neutral as we will see on gold and running a flat net exposure. It feels that the technicals on USD-denominated gold effectively marry perfectly with futures positioning.

One interesting chart we see working is the gold/silver ratio, which now sits at the highest levels in 26 years. One questions how much juice is left in this trade, but being long gold and short of silver as a pairs trade has worked incredibly well over any timeframe. Clearly, it’s the silver side of the equation showing weakness, with spot -7% YTD, while gold is unchanged YTD.

So, if the bond market is failing to promote a spark in gold, what is holding it back? Well, I would firstly focus on financial market volatility, which if we look at equity volatility (vol) we see implied vol (I’ve looked at the VIX index) in the S&P 500 still below 18%, which hardly shows expectations of big range expansion in price. It feels for gold to really motor on then vols really need to pick up here. We can also see implied vol in G10 FX markets sitting at 6.79% (I am looking at the JP Morgan implied volatility FX index), which is a reasonable discount to the one-year average of 7.92%.

When all DM central banks are moving policy in alignment then vols are suppressed. What we really need to see is emerging central bank divergence and clear differences in policy settings. This would cause higher vol and put a better bid in gold.

The USD effects

Another consideration has to be the USD impact. As we can see from the daily chart of the USD index (USDX) price looks to be breaking out into new highs. Consider that the EUR has a 57% weight on this basket of currencies traded against the USD, so flip the chart to EURUSD and we see price trading into the lower limits of tis 1.1260 to 1.1110 range it’s held since late April. A close through 1.1110 will only limit golds (in USD) appreciation and this takes on new consideration ahead of the ECB meeting on 6 June.

If this bullish run in the USD continues, why not look at trading gold denominated in AUD (XAUAUD) or EUR (XAUEUR). At Pepperstone we let you take the USD out of the equation.

Gold in AUD terms – Patience is required here, but it is on the watch list.  A firm close through A$1880 and the prospect of a move into and above A$1900 looks elevated.

Gold in EUR terms – Again, the preference is to let price guide and force a trade and through the double top at EUR1162 and this should trend higher. If we expect the ECB meeting to be dovish and a EUR negative, pushing EURUSD through 1.1110, then EUR gold should be on the watchlist.

Chris Weston, Head of Research at Pepperstone

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