- Gold prices and 10y US Treasury yields moved lower…
- …which is an unusual combination
- A modest rise in the US dollar…
- …disappointment on the monetary policy front…
- …and impatient investors are the main reasons for this
Gold prices react in an unexpected manner…
Recently, gold prices reacted in an unexpected manner. US Treasury yields moved lower, while gold prices also moved lower. In general, gold prices rise if US Treasury yields decline. This is because lower US Treasury yields in a risk averse environment result in higher demand for assets with safe haven characteristics (gold is among those assets). Moreover, lower US Treasury yields make gold as an asset more attractive to invest in, as it does not have a yield.
Why did gold price behave like this? We think that there are three forces at play. First, the US dollar rose modestly. Gold has a strong negative relationship with the US dollar. This is a dominant driver for gold prices (see graph below).
Second, the ECB, BoJ and the Norges Bank have been less dovish in their actions and communications compared to market expectations. As a result, this has made the case for gold and silver less strong.
Last but not least, investors are already positioned for higher prices (see graphs below).
The gold price action over the recent months has disappointed investors. As a result, they have been starting to think that the rise in gold prices is over. It appears that some impatient investors have started to sell gold positions when prices approach USD 1,350 per ounce. The failure of gold prices to stay above USD 1,340 per ounce could have resulted in investors lowering their offers. It is likely that gold prices will first revisit the lower border of the range at around USD 1,300 per ounce. If this level remains in place, gold prices could move back towards USD 1,335-1,340 before the move is losing momentum again. This process of the market testing both sides of the range could continue for a while. But both borders will probably converge until there is finally a breakout. If the lower border is broken, prices could quickly fall towards USD 1,250 per ounce where the 200-day moving average comes in.
Our base scenario remains for gold prices to stay in a USD 1,300-1,350 per ounce for now. Over time (H2 2017) we expect gold prices to break out on the upside for the following reasons:
1. US inflation will likely be higher than growth
2. US real interest rates are forecast to remain negative (less negative though)
3. The longer-term US dollar trend has turned negative
This range will likely be broken earlier if Trump becomes President and/or if investor sentiment deteriorates sharply. This would result in sharply higher gold prices. Another scenario is that US economic growth picks up strongly triggering the Fed to hike rates aggressively in an environment of constructive investor sentiment. This would be a bull case for the US dollar as US real rates would also rise substantially. In this scenario the US dollar uptrend would have another leg while gold prices could drop below their 200-day moving average of USD 1,250 per ounce signalling that the uptrend is over.