The most talked about commodity which instantly portrays an image of wealth and class. Transactions in the over the counter market fluctuate into the billions so the market is liquid and more importantly has good volatility to be able to trade, but is it safe?
Like all markets that we as traders look to exploit, it is imperative that we manage the trade well, both analytically and in terms of risk therefore to answer this question we must understand what has been driving the market in recent years thus understanding future opportunities.
After the huge bull run of 2011 and a year of consolidation in 2012, the sellers have taken control in 2013 with the price of gold coming under significant downside pressure. Moving into the last quarter of the year, the trading range this year has been almost double that of 2012, with an upper limit of around $1700 before the sell-off hit a low of $1180.
There were several key drivers of the gold run in 2011. With the lack of income stream (or dividend) from gold, in a negative real interest rate environment there is very little opportunity cost of owning gold.
The tough economic climate driven by the Eurozone sovereign debt crisis pushed investors into safe havens such as gold. Though probably what was more important was the proliferation of liquidity expansion globally. This was manufactured by the world’s major central banks like The Federal Reserve, Bank of England and The Bank of Japan, by expanding balance sheets and printing money through quantitative easing.
Depreciating currencies made the hard asset of gold, which is finite in supply, relatively more attractive. A weak US Dollar is bullish for gold which is a store of value and arguably, an inflation hedge. The announcement of expansionary, interventionist policies from global central banks, such as QE3 from the Fed, resulted in strong gains in the gold price. Despite the continuation of ultra-loose monetary policy from the key central banks in 2012, the gold price struggled to make any headway. Predictions of $2000 per ounce that were banded were never fulfilled, as the resistance of the $1920 all-time high remained intact. The market saw gold as a non-yielding asset class therefore money-flows into equities saw a rise in stock prices which is still evident now by new highs being reached. This can be seen in the chart below displaying the all-time high being hit in the S&P 500.
The precious metal has struggled to recover from Q2 OF 2013 that indebted Eurozone countries such as Cyprus would be required to sell their gold reserves in order to help finance their bailouts. The gold price subsequently dropped over 15% in just three days. It took another hammering in June ’13 when Ben Bernanke started to talk about the Federal Reserve reducing its asset purchases. Gold fell almost over 12% in just a couple of weeks.
However, there is something of a natural fundamental floor for the gold price that has been supportive. The marginal cost of production for gold for the less efficient gold producers comes in around $1150/$1200 per ounce. This would mean that around these price levels, gold becomes uneconomic to mine and the supply becomes more restricted, which should act as a form of an organic natural support.
This year has seen the buying of gold by central banks at its highest levels for over 6 years, as reported by analysts at Macquarie. A total of 264 tonnes of gold have been bought so far, dominated by Russia, Turkey and Kazakhstan. These figures show a welcomed reprieve for the yellow metal, with a surplus of supply being created by very little demand from the markets. Diversification of reserves away from the US dollar is seen to be the prime rational for the uptake from central banks. With the price of gold at -8 % YTD it is understandable that gold be used as key instrument of diversification. That being said, with the obvious strength in the US dollar and rising US Bond yields, (over the course of 2018), a continuation will not help the market for an optimistic bullish outlook.
Top Tips for Trading Gold
· Always check the performance of the US Dollar or dollar index, there is a inverse correlation between them. If USD goes up in value, then the price of gold goes down and vice versa!
· Take note when the market is in a “risk on” or a “risk off” sentiment. When you the market is an “risk off” sentiment we will likely see a flight to safe havens such as gold. This will see an uplift in the price of the yellow metal.
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