ETF Securities: Trade Idea: Commodities Gold Plunges in Asian Trading

Fundamentals – Rate Hike Pressure Should Ease: Long-term fundamentals, in particular, around interest rate expectations once rates are raised, should support gold. We believe that as the impact of the Federal Reserve’s initial rate hike dissipates later in the year, the gold price will stabilise and/or move higher…

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The gradual nature of the upcoming tightening cycle should eventually relieve negative sentiment and see a return of gold to more familiar levels around US$1,150-US$1,250/oz range. Even before the rate hike materialises, should US economic performance disappoint and rate hike expectations get pushed out to 2016, the gold price could witness a considerable correction from current levels. Outside of the US, the European Central Bank (ECB), Bank of Japan (BoJ) and the Peoples Bank of China (PBoC) look set to continue quantitative easing. This should ensure that gold demand from these regions remains stable and support a long term recovery in gold price (see:Outlook Q3-15: What Happens WhenFundamentals Reassert Over Sentiment).  

– There is a particularly large caveat: currently in the gold space, fundamentals appear to be overlooked or even ignored. Sentiment is driving the market and for many investors, it would appear gold is decidedly out of favour.

Bullion drops Precipitously

– Gold crashed through a number of psychologically important levels recently, going from over US$1,150/oz to below US$1,100/oz level in a matter of days. Gold is in the midst of a bear market as negative sentiment and technical factors combine to drive prices lower. Bearish Factors Assert

The following 3 factors drove last week’s selloff and are likely to ensure that negative sentiment toward the yellow metal persists in the near term:

– Yellen’s testimony to US Congress proves to be bearish for gold prices. The US Federal Reserve chair’s speech was interpreted by the market as hawkish and pushed forward rate hike expectations. The testimony indicated that, should the US economy evolve according to US Federal Reserve expectations, an earlier rate hike would be warranted in order to pursue a more gradual path of monetary tightening. Thus, the release of healthy US inflation and housing data a few days later, acted to push gold prices to a five year low and prompt the US Dollar to appreciate against major global currencies. Gold is a non-yielding US Dollar denominated asset and so suffers as prospects of higher rates and a stronger US Dollar increase.

–   Fears of “Grexit” subside. Following the successful approval of economic reforms by the Greek government last Thursday, the European Union has agreed to provide bridge financing until the terms of a third bailout package can be established. Although the situation remains somewhat vulnerable to political instability within the Greek parliament, the markets appear to be showing clear signs of relief, removing some safe haven support from the gold space.

– China’s gold hoards disappoint. The PBoC announced on Friday the extent of its gold reserves after six years of silence. The announcement revealed that the PBoC had increased its gold stockpiles by 57% over the last six years to 1,658 Mt, less than the market had expected. The revelation disappointed analysts and failed to stem the decline in gold prices. Going forward, we believe that Chinese physical demand may become a key factor supporting gold prices if they continue to drop. History has shown that lower gold prices can trigger purchases from more price sensitive buyers in China and India. These nations combined currently account for approximately two thirds of global gold demand.

Technicals Display Downward Trend

As of Friday’s afternoon fix, the gold price was sitting at 5.6% below its 200 day moving average (dma), illustrating the clear downward trend that has characterised the gold market as of late (see Figure 2). The extent of recent downside movements has pushed gold’s 15dma to almost 2% below its 50dma. This would suggest, from a technical perspective, that in the short term the gold price is likely to continue its path lower.


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