Gold prices are on the verge of breaking to fresh seven-year highs despite conditions that are not ideal for the yellow metal.
Gold prices fell sharply in early March during a time of panic where the yellow metal usually thrives. The tables have turned since then and gold is on the verge of breaking to fresh highs not seen since 2012 even though there are forces against precious metals.
A Stronger Dollar is Doing Little to Contain the Gold Rally
Price behavior in early March was surprising for gold traders. The shiny metal usually does well during times of uncertainty and there was a big shift to risk aversion during this time as the Coronavirus threat escalated.
However, investors showed a strong preference for the US dollar which inevitably weighed on gold prices.
Interestingly, the greenback has shown strength once again since the middle of April. The rally isn’t nearly as strong as early last month but on a trade-weighted basis, the greenback is up about 2%. As of the European open on Friday, the dollar index (DXY) is on the verge of breaking to fresh highs for April.
The dollar and gold prices have a long-standing inverse relationship with each other. The fact that the yellow metal is able to rally along with a stronger dollar is the first reason I am bullish gold.
US Dollar Index (DXY)
Stocks have Rebounded Nearly 30%
Another common inverse correlation is between gold prices and stocks. In the bigger picture, these two assets don’t usually move in the same direction.
A divergence was seen in the second half of 2019 and both the S&P 500 and the price of gold gained notably during that time.
The same thing is happening once again as we’ve seen the S&P 500 and gold prices both bottom at around the same time in late March.
The big difference here is that gold is outperforming since bottoming when adjusted for volatility. Even though the yellow metal is up about 19% versus the almost 30% gain in the S&P 500, gold has broken above it’s March high while the equity index still needs to rally another 22% to do the same. The outperformance is the second reason I believe there is more upside for precious metals.
Gold Performance vs S&P 500
Gold Mining Stocks Are Breaking out
The final and the biggest reason why I expect more upside in gold is because the Gold Miners ETF (GDX) is signaling a technical breakout.
GDX has crossed above a horizontal level near $32 which had held it lower in 2016 and earlier this year. The ETF has broken to a fresh seven-year high this week as a result.
I put a lot of emphasis on this technical development because GDX has otherwise been an under performer. Consider that spot gold broke above its equivalent 2016 high over the summer last year and is up about 30% since then.
When weak instruments within the same asset class start to show strength, there is a good chance a big move is coming.