The Factory Daily Letter
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The technical outlook for gold is enticing
And should it take up momentum again, this would bode well for the gold miners
Yesterday’s US CPI report for April showed that inflation (year-on-year) fell for the first time in eight months, but it remains stubbornly high, supporting the notion that the Fed will have to remain hawkish. That said, evidence that investors are developing an appetite for some bottom-fishing appears to be emerging.
The data released yesterday showed that US inflation did not decelerate at the expected annual rate, it falling from 8.5% to 8.3% compared to the consensus forecast of a larger deceleration to 8.1%.
The risk that inflation continues to run well above the Fed's threshold has increased, reinforcing the idea that the Fed needs to raise rates more aggressively to slow it down (albeit at the risk of stalling growth). Immediately following the reading, equity markets came under pressure at the market open (and 10-year rates remained above 3%) before bouncing back close to pre-print levels; but then selling off lower yesterday with Tech stocks leading the downtrend after CPI print. The S&P 500 closed -1.65% lower breaking the 4,000 level while the Nasdaq ended -3.2% lower.
As for gold, the current situation looks mixed, but yesterday's positive action, which saw the price bounce off its 200-day SMA support, could be a positive signal for renewed interest in gold that could lead to the positive trend resuming.
In the current environment, gold may be attracting investors for a number of different reasons. If the dollar takes a breath, then gold should benefit. On the other hand, if inflation falls less quickly than the consensus forecast, then this could support gold as an inflation hedge.
But gold is facing conflicting forces
During the first equity market decline of the year – that which ran from January to March - gold gained 16% rising 1,780 to 2,070 dollars per troy ounce as it benefitted from its traditional safe haven status. However, the price failed to break above its former high and a new phase of consolidation materialised.
However, this time, when equities have been suffering this more recent wave of sharp declines, gold has been dragged down with them, apparently losing its safe-haven appeal. Among other reasons for this is the strength of the US dollar and a hawkish Fed; but the lack of gold buyers also reflects investors' risk aversion in the face of a growing number of broader concerns (while the break of an important technical short-term support may have also triggered some automatic sell orders by trend followers, exacerbating the gold’s recent downward movement).
A pullback in the US dollar may help gold to rebound
The technical chart below illustrates how it, having formed a double bottom at around 89.40 in mid-2021, the Bloomberg dollar index started to rise again, breaking through a series of intermediate resistances before approaching major resistance at 97.80 (the 61.8% Fibonacci retracement of the whole downward sequence that started in March 2020). However, contrary to our expectations, the subsequent pullback failed to take hold and returning positive momentum then managed to push the index above this key level. Since then, the index has continued to rise despite brief signs of momentum exhaustion.
Short-term, the dollar index has now reached 2016’s high just shy of 104, and the RSI is now looking extremely overbought. Does this mean a pause might finally occur? If so, the 50-day SMA, currently at 99, should act as a support:
Gold has historically tended to benefit from high inflation
It is widely known that gold has historically provided a good hedge against inflation. As shown on the graph below, when US CPI has been running above 6% (blue areas), gold has performed well:
US real rates and the gold price have diverged recently
Traditionally, the gold price tends to move in opposite direction to US real rates as the opportunity cost of holding gold – that does not produce any income – rises. As shown on the graph below, the US 10Y real yield (in grey, inverted scale) has been diverging from the evolution of gold price (red). Indeed, the sharp rise in real yields in the US – due to the ongoing Fed’s monetary policy tightening – but gold has been quite resilient. As discussed below, the demand from gold-backed ETFs has been supportive of gold prices in Q1 2022:
ETF flows have remained strong despite the recent pullback - and should remain supportive as long as the support held
The recent decline in gold seems to have been relatively contained, especially in relation to the sharp acceleration in 10-year real rates. According to the World Gold Council, the rise in investment demand – particularly from ETFs – has been strong over Q1 2022. Net purchases from central banks have also risen compared to Q4 2021, offsetting the lower jewellery and technology demand.
The chart below shows how gold demand from ETFs and gold spot price tend to move in tandem, even though the price of gold tends to drive demand for ETFs. In the short term, the demand for ETFs has only moved slightly despite the pullback in gold. Technically, gold is currently at a key technical support level and if it holds should reflect demand resuming its ascent:
Technically, the trend remains positive as long as the price remains above the 200-day SMA
During the first part of 2022, the precious metal benefited from rising volatility and a series of positive breakouts triggered a rise towards the previous high (above 2k). Since then, the positive momentum has faded and a consolidation phase has materialized.
Short-term, the consolidation has reached an important support at 1,836 (defined by the 200-day SMA). Our core longer-term scenario is that the positive momentum resumes towards 2,300 (the target of the triangle breakout):
Gold miners still have some catching up to do
Gold miners (GDX US), which have underperformed the broader market since April, may be set for a technical bounce if the positive momentum in gold resumes.
The chart below shows relative performance of gold miners versus the S&P500 (in grey) compared to the price of gold (in red). While both gauges have tended to move in tandem since 2017, they have diverged significantly since 2020. The underperformance of gold miners looks exaggerated on this basis suggesting that a rebound may occur, in our view:
In the table below we present the results of our screening of the global gold miners with an overall (global) score of more than 50, ranked by lowest RSI. If a rebound in gold materializes, such could benefit most from a tactical rally. Note that they are currently trading at least 15% below both their consensus target prices and their 52-week highs, offering an attractive risk/reward ratios in our view:
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