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Gold has broken higher through its long term downtrend line with the most
recent rally. This break begs the question of how much longer gold can
continue rallying. In this article we analyse the technical situation for
gold to determine at what level gold is likely to cease rallying, the
fundamentals in play, and what would have to change to cause a new bull
market in gold.
The Technical Limits for Gold
The peak in gold prices came in 2011 and trended lower after this, but the
technical gold bull market did not break until April 2013. Since this break
and the beginning of the bear market gold has had upward resistance from a
downtrend line that has held steady despite a number of rallies in gold.
However, gold has now moved above this resistance and, more importantly,
closed above it.
Now that this level is broken the next major resistance is at $1275, then
close to $1400 with the downtrend line that has been in place since the
all-time highs were made in 2011. The question is, can gold challenge these
levels?
The above graph shows every bounce that gold has made since it peaked and
the magnitude of each bounce. The largest of the bounces saw the yellow metal
rally 18.06% and gold is currently up 13.28% from the lows made last year.
This means that if gold moves above $1250, then we will be in the strongest
period for gold prices since 2011.
The Cause of the Current Bounce
For gold to sustain its strength and continue rallying above $1250 there
will have to be a significant shift in the fundamental situation. The
current movement can be accounted for by the removal of a key bearish
catalyst: The Fed hiking.
Fears around China’s currency devaluation and a lack of inflationary
pressures has caused a risk off tone in markets. While these volatile
conditions persist the Fed will not hike rates, and will instead take a
dovish stance as they did at their January Meeting. As a result market
pricing for a single rate hike by the end of year has fallen to only 21%.
This is in stark contrast to the situation following the rate increase in
December, when the markets had priced in between two and three hikes and the
Fed predicted at least four hikes would be required.
Without the bearish catalyst of a new hiking cycle to drive gold prices
lower the metal has recovered considerably. However, the removal of the
bearish catalyst does not mean that a bullish catalyst is now in place. Gold
could simply trade sideways until economic and market conditions allow the
Fed to hike again. Accordingly, for gold to rally above $1250 there would
have to be a new, heavily bullish factor would have to come into play.
Dovish Policy is the Only Long Term Bullish Catalyst
Any event that causes safe haven buying, such as increased geopolitical
threats, are likely to drive gold higher. However, these rallies are
generally reversed once the risks decreased and those who bought gold as a
safe haven asset exit their positon. This means that although safe haven
buying has the potential to drive gold higher, it will not be a catalyst for
a new bull market.
We believe the only factor that can drive a sustainable bull market in
gold is more dovish monetary policy from the Fed. The strong inverse
relationship between gold and real rates implies that any major dovish action
would drive gold higher. This includes targeted quantitative easing measures,
such as QE3 and the programs currently being used by the ECB. Although these
types of programs have not been bullish for gold, any measures that would
drive US interest rates lower would fuel a bull market due to the strong
inverse relationship.
Therefore, although gold prices are currently rallying hard, we believe
that their momentum is unlikely to be sustained as there is no bullish
catalyst to ensure that prices rise over the longer term.
How Far Can Gold Rally?
Gold is limited technically by its past performance and specifically by
its bounces since the peak, which implies a technical limit around $1250.
Before then gold will have to push through resistance at $1225 and overcome
any profit taking triggered by the RSI showing the metal to be considerably
overbought.
To overcome those technical limits the fundamental situation would have to
change. This means the introduction of a new bullish catalyst for gold, such
as new easing or rate cuts from the Fed. Although the conditions in the
financial markets and the inflationary outlook are bleak, the Fed does not
have a reason to ease policy at this point. Clearly they have reason to not
tighten, but we are not yet at a point where new easing is needed.
Even if the situation continues to worsen from here and a rate hike
becomes entirely priced out for 2016, this does not mean the Fed would start
new easing. It is likely that the economic situation would have to severely
weaken to see this take place. Given recent economic data, such as the
employment report last Friday that showed wage inflation rising, we believe
that it is unlikely that the Fed will need to ease policy.
Therefore, we believe the limit for gold is $1250. This means that
aggressive long positions on the yellow metal currently hold poor risk reward
dynamics. Rather, we are targeting topside protection trades and
conservatively bullish trades on the metal. With gold highly unlikely to
break $1250, but also unlikely to fall significantly, it makes sense to take
on these types of trades. If you wish to receive the trading signals with the
details these trades, you can become a subscriber via either of the buttons
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