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Gold’s Shine Diminished Amid Economic and Political Backdrop

November 15, 2016

Although the financial market reaction to the election results was volatile, the subsequent rally in risk assets and the US dollar spells increased confidence in the US economic outlook.  The impact has been a rapid reversal in safe haven flows, with precious metals and other risk aversion assets facing steep losses.  The predominant place this has been most evident is with gold prices.  After spiking as high as $1318.60 per troy ounce on the announcement of Donald Trump’s victory, gold prices have since fallen over $100.00 per troy ounce to just above $1200.00.

While it is easy to pin gold’s losses on the election outcome, there are a number of other factors that are causing the market to be increasingly confident in the outlook.  For one, the likelihood of the Federal Reserve raising rates in December has increased tremendously.  Gold typically does not perform well in a rising rate environment as investors pick assets with yields over those that merely store value.  Second, with inflation on the rise, more rate hikes may be possible, further reducing the need to hold gold as a hedge against uncertainty.  Considering these developments, the case for holding gold as part of an investment portfolio has been greatly diminished.

A More Solid Outlook

Despite the election commanding most of the coverage over the last few weeks, there has been a rapid improvement in the metrics the US Central Bank uses to help determine its policy decisions.  Strong job creation figures combined with rising inflation have all created the necessary conditions for the Central Bank to carry out its promise of policy normalization.  This involves moving interest rates from near-record lows back to levels corresponding with a vast improvement in economic activity.  As recent preliminary data related to growth showed, the US economy grew at the fastest pace in 2-years during the third quarter.

These developments contrast sharply with the reasons for holding gold in an investment portfolio.  Precious metals are typically useful assets to accumulate during significant economic uncertainty or periods of pronounced inflation.  However, during a period of rising interest rates, yields on other assets are likely to improve.  Unlike stocks and bonds, gold is a non-yielding asset.  That means that holders are not periodically rewarded for holding the asset.  Gold bulls can only benefit from rising prices of precious metals whereas a holder of a company’s stock can benefit from a company that generates value and returns value to shareholders in the form of dividends or other distributions.

Now that speculation is rising that a rate hike is highly likely during the upcoming December FOMC meeting, the argument for holding gold has weakened dramatically.  A period of rising interest rates is expected to benefit the US dollar.  When fiat currencies rise in value, precious metals typically exhibit the opposite reaction.  After hitting an 11-month high on Monday, the rally in the dollar may just still be in an early phase, especially if the Federal Reserve plans to continue raising interest rates after December.  As a result, these numerous pressures will keep a lid on any upside in gold prices over the medium-term.

Technically Speaking

Gold prices have long had a strong inverse relationship with the US dollar.  What this implies is that when the US dollar is rising, gold prices are generally falling and vice-versa.  While there are exceptions to this rule, the correlation between the two assets shows that the relationship at -0.8706 is very strong at present.  Generally, the closer to -1.00, the stronger the inverse relationship.  Therefore, if the US dollar continues to rally, expect gold prices to continue slipping as a result.  Adding to the downward pressure on gold prices are the moving averages.

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With both the longer-term 200-day moving average and medium-term moving average trending above the price-action and acting as resistance, they may stand in the way of any rebound in gold prices.  Furthermore, the 50-DMA crossing the 200-DMA to the downside would be viewed as a highly bearish development that would likely be accompanied by accelerated downward momentum.  While the Relative Strength Index is implying price momentum that is currently oversold and potentially precedes a bounce, any upward correction might be an excellent point to establish bearish positions.

Looking Ahead

The key developments that could impact recent gold momentum are upcoming figures related to inflation.  Both US producer and consumer price inflation numbers are set to be reported later in the week.  Should these measures continue to rise, the probability of interest rate hikes will also likely increase.  These developments may spur additional dollar buying, whereas disappointing figures may dent Dollar optimism.  However, if inflation shows growth and November job creation remains above 100,000, gold prices may be set for a tumble back towards multi-year lows at $1050.00 over the coming months.