Why Gold's Longer-Term Recovery Has Legs
Many pundits view gold's latest rally as a flash in the pan.
They forget that it's a small part of a two-year recovery effort.
An improving global economy will bolster gold's longer-term prospects.
Despite a strong start to the New Year, many investors - retail and institutional alike - remain unconvinced of the strength behind gold's recovery. More than a few pundits have voiced the opinion that gold's recent strength is ephemeral and will soon give way to renewed selling pressure. These analysts seem to have forgotten that independent of gold's six-week rally is a much broader recovery which began two years ago. In this commentary we'll discuss the likelihood that gold will continue its longer-term recovery trend in spite of the bears' skepticism. We'll also examine the primary motive force behind that recovery.
A brief review of gold's longer-term performance is in order before we begin. Although gold rose more than 9% in 2016 and a further 7% in 2017, its first back-to-back gains in several years, it finished the year under its Sept. 8, 2017, high of $1,355 and well below the July 2016 closing high of $1,375. Gold's weak finish to 2016 was largely due to the market's expectation of a strengthening of the U.S. economy under the incoming Trump administration. Investor expectations of higher interest rates and higher stock prices in 2017 triggered an unwinding of safe haven trades in both gold and government bonds in Q4 '16.
Yet surprisingly, the gold price rebounded from its 2016 post-election lows in 2017 and trended higher for most of the year. The fact that gold has rallied over the past year despite a steady decline in investor uncertainty and global market fears is remarkable. It attests to the attraction of the metal as more than just a safe haven trade.
Source: www.Barchart.com
More recently, gold has benefited from a technically oversold condition after last month's decline. It also has benefited from recent weakness in the cryptocurrency market. After confirming a buy signal by closing two days above its 15-day moving average last month, the gold price has remained above the benchmark immediate-term trend line since then as the bulls continue to hold the advantage.
Not everything has been supportive of gold's latest rally effort, though. As discussed in my previous commentary, the gold price should ideally receive technical support from the price of silver in order to strengthen gold's near-term prospects. Instead of confirming gold's latest strength, however, the silver futures price (basis March) is currently below its 15-day moving average and showing signs of struggling. Historically, prolonged relative weakness in the silver price vis-? -vis gold has served as an advance warning of reversals of the gold price trend.
Source: www.Barchart.com
Silver's lagging performance (see above chart) need not threaten gold's established longer-term recovery, which began in 2016. The silver price is, after all, still above its low from 2015 and is building a longer-term basing pattern. Silver's immediate-term lag vs. gold is merely a reflection of a temporary imbalance between the two metals which may require a consolidative pause or pullback in the gold price in order to re-synchronize with the silver price. But by no means does silver's lagging performance threaten gold's longer-term recovery.
It is well known by investors that uncertain times usually bode well for gold since the yellow metal is a prime haven for safety-minded investors. But while uncertainty can serve as a major supporting factor for gold prices, by itself it's unlikely to carry the gold price to substantial heights. Something more meaningful is needed for that. In the longer term, gold prices are driven primarily by two major factors: Sustained inflationary pressure or sustained deflationary pressure. Anything that threatens to undermine U.S. dollar strength bodes well for gold's intermediate-to-longer-term outlook. Runaway inflation isn't needed to boost gold's price, but continued weakness of the dollar index would certainly suffice.
Source: www.Barchart.com
Indeed, the sustained erosion of the dollar, as reflected in the above graph, is one of the biggest arguments for the continuation of gold's longer-term recovery. While some commentators are blaming the recent tax cuts for helping to drive down the dollar's value (as a Jan. 22 article by Yahoo Finance reporter Dion Rabouin argues), the real reason for the dollar's weakness has as much to do with the gradual recovery of the global economy. Until last year, overseas investors were piling into the dollar as the eurozone and other foreign economies were beset with weakness. Now that the outlook for many industrialized nations, including France and Germany, are looking up, investors are turning to the euro and away from the dollar. Regardless of other technical factors, a weakening dollar will boost gold's recovery prospects in the coming months.
For disclosure purposes, I'm long the iShares Gold Trust (IAU) with a $12.70 level stop-loss on a closing basis. I'm also currently long the VanEck Vectors Gold ETF (GDX), which is my favorite proxy for the actively traded gold mining stocks. I'm using the $23.50 level as the stop-loss for this trading position on a closing basis.
Disclosure: I am/we are long IAU, GDX.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.