The third quarter of 2017 was positive for the gold market. The yellow
metal has gained more than 3 percent between July and the end of September.
As one can see in the chart below, the price of gold jumped above $1,300 for
a while and even approached the 2016 highs.
Chart 1: Gold prices (London P.M. Fix) from January to September 2017.
What were the reasons behind that impressive upward move? The popular
story says that worries about North Korea triggered a rally in gold prices.
However, as we showed in the September edition of the Market
Overview, “gold’s reactions to geopolitical developments,
including these about the country ruled by the Kim dynasty, are usually
merely short-lived and limited.” Indeed, for example, although North
Korea uttered new threats and launched another missile in the penultimate
week of September, gold prices retreated.
And, importantly, despite elevated geopolitical
risks, global risky asset markets remain largely unaffected, while the
market fear gauges are still very low. Both the CBOE Volatility
Index and credit
spreads increased in the first half of August, but the pricing of risk
returned soon to very low levels, as the chart below shows.
Chart 2: The market volatility reflected by the CBOE Volatility Index
(green line, right axis) and the credit spreads reflected by the BofA Merrill
Lynch US High Yield-Option Adjusted Spread (red line, left axis, in %) over
the last twelve months.
It implies that other factors – related to macroeconomics rather
than geopolitics – had a bigger impact on gold in the analyzed period.
In particular, the
U.S. real interest rates and the
greenback were the most important fundamental factors that influenced
gold prices. Indeed, gold prices plotted in the chart below look like a
mirror reflection of the moves in the real interest rates.
Chart 3: Gold prices (yellow line, left axis, P.M. London Fix) and the
real interest rates (red line, right axis, yields on 10-year Treasury
Inflation-Indexed Security, in %) over the last 12 months.
The drop in real interest rates in July and August was mostly caused by
the decline in the market expectations of a Fed hike in December after dovish
Yellen’s semiannual testimony before the Congress and the slowdown in
inflation. The market odds of at least one 25 basis points upward move until
December plunged from about 62.3 percent at the beginning of July to 31
percent at the beginning of September. Gold prices rallied then. But since
then, the market chances rose to more than 80 percent at the end of month,
while the price of the yellow metal retreated. The negative correlation
between target rate probability history for the Fed meeting in December and
gold prices is presented on the chart below.
Chart 4: Gold prices (yellow line, left axis, London P.M. Fix) and the
market chances that the target for the federal funds rate will be higher than
100-125 basis points until December Fed meeting (red line, right axis).
The relationship between the U.S. dollar
and gold in the third quarter of this year also looks like a mirror
reflection (although they both moved in tandem at the beginning of July), as
the chart below shows.
Chart 5: Gold prices (yellow line, left axis, London P.M. fix) and the
U.S. dollar index (red line, right axis, trade weighted index against major
currencies) from September 2016 to September 2017.
Actually, the collapse in the U.S. dollar has been the dominant
macroeconomic theme recently. The greenback has been falling like a
stone this year – and what initially looked like a correction turned
into carnage during the summer. Importantly, the U.S. dollar has
recently declined due to some geopolitical worries (such as crisis
over Korean Peninsula) – while in the past it used to gain during periods of
global uncertainty. This could suggest that the bull market in the greenback
might have ended, which actually would be in line with the long-term pattern
of seven-nine cycles in the U.S. currency. However, it could also mean that
there were other factors that made the USD decline (for instance, the
self-fulfilling prophecy regarding lower prices – USD declined for a long
time thus everyone kept on selling it as it seemed to never recover). It goes
without saying that worries about the removal of the debt ceiling and doubts
whether the Trump administration would achieve any of its legislative
promises in the near future do not help the dollar.
Having said that, the short-term prospects look more obvious. Before the
September FOMC meeting, we wrote: “given the current level of speculative
long positions, gold seems to be overbought (while the U.S. dollar oversold),
so we could see a correction in the near term, especially if the Fed stays on
its tightening
course, as we believe that it does.” This is precisely what happened.
Although the drop in gold prices in the aftermath of the recent FOMC meeting
wore off a significant part of gold’s overbought status, there is room for
further declines, at least until the Fed sends a dovish signal.
If you enjoyed the above analysis and would you like to know more about
the impact of the current macroeconomic trends on the gold market, we invite
you to read the October Market
Overview report. If you’re interested in the detailed price analysis and
price projections with targets, we invite you to sign up for our Gold &
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Thank you.
Arkadiusz Sieron
Sunshine Profits‘ Gold News
Monitor and Market
Overview Editor
Gold News Monitor
Gold
Trading Alerts
Gold
Market Overview
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