Battered gold shows resistance amid US weakness

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There has been an inverse correlation between the US dollar and gold price, which, combined with the fact US equities are starting to look rich, suggests the commodity could rise to August highs.

Gold showed it is not finished as a safe-haven play last week, as disappointing US economic data and a weaker dollar drove Comex gold futures to $1,352 per ounce, an increase of 3% on the week.

Gold has fallen nearly 19% so far this year, as institutional and retail investors turned their back on the bullion on expectations that the Fed would begin tapering its quantitative-easing programme this year.

However, a series of unfortunate events for the US economy in October have driven a two-week rally for the precious metal, catching some shorts unawares.

“The US government shut down and debt-ceiling crisis helped prices rise a little bit last week, while a bad jobs report this week added more probability that monetary easing will not slow down over the next few months,” says Rohit Savant, senior commodity analyst with research and trading firm CPM Group in New York.

“Furthermore, the uptick in pricing led to a lot of short-covering and for now we have evened out at around $1,350 to $1,352.”

Delayed by two weeks by the government shutdown, the release of September’s non-farm payrolls data on Tuesday showed that the US economy added 148,000 new jobs in August, undershooting expectations of 180,000.

Meanwhile, weaker-than-expected consumer confidence data and core durable goods orders for October released on Friday added to the sense that the US recovery is in a soft patch. However, investors must now wait until November to determine the impact of the government shutdown on its fragile economic recovery.

With weaker-than-expected data crystalizing market conviction around the belief that the Federal Reserve will maintain the pace of its bond-purchasing programme until the end of the first quarter next year, the dollar weakened sharply, falling to a two-year low against the euro. Indeed, an uncertain and difficult US outlook is likely to support further short-term gains for gold investors.

Michael Smith, president of T&K Futures and Options brokerage in Florida, says the falling dollar and the perception that US equities might be overvalued could drive gold back to the annual highs of $1,434 set in August.

“We have seen inverse correlation between the US dollar and gold prices, and continued dollar weakness implies that we could see a run back up to the highs of August,” he says. “Meanwhile, some investors are starting to think that US equity market valuations could be stretched, with the consequence that capital [will] head offshore and into precious metals.”

Although gold and the US dollar have displayed a substantial negative correlation in recent weeks, CPM’s Savant says, taken over the longer term, the relationship is not particularly strong and tends to break down when fresh information becomes available.

“While investors tend to draw the conclusion that gold and the dollar have an inverse correlation, in fact gold exhibits both proportionate and inverse correlation to the dollar,” he says. “In both cases the relationship is not particularly strong.”

Although long-term investors have become averse to increasing positions in rising markets after several years of price appreciation, Savant says the structural issues facing the global economy have not gone away.

“It could be rational to buy at the current levels, and although in the short-term prices will move sideways, we might see them moving up again around 2015,” he says.

“The trade deficit problems facing developed market governments and the trade imbalances between developed and emerging markets that have built up over a number of years are not going to be resolved quickly. In the meantime, economic volatility could support higher long-term gold prices.”

Although government restrictions on gold imports have put a substantial crimp on physical volumes going into India, the arrival of the wedding and festival season should put a floor on prices at around $1,300 for the rest of the year.

“Government restrictions have driven a sharp increase in premiums in India of around $100 per ounce, and physical buyers have become a little less price sensitive, given the reduction in available volumes,” a commodity trader concludes.

“The restrictions, coupled with increased seasonal demand, should mean gold stays above $1,300 for the rest of the year.”