Commodities

Gold advances as USD collapses, but risk of a correction appears elevated – Commodity news

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Gold prices advanced in January, as the weaker US dollar and some seasonal effects boosted the appeal of the precious metal. While gold’s broader direction still appears to be higher, there is an increasing risk of a near-term correction lower, before the next leg up in the metal.

Gold, like most other precious metals, is traded in US dollars. The implication of this is that when the greenback falls in value, the dollar-denominated metal becomes “cheaper” to buy for investors that use other currencies, a factor that usually drives gold prices higher. Vice versa, an appreciation in the greenback usually spells bad news for gold. This pattern can be clearly seen by looking at a chart of the two; gold and the dollar are inversely related.

The dollar index has shed 3.5% of its value thus far this year, while gold has gained more than 2.5%, even in the absence of any major risk-off events that drive safe-haven flows into the precious metal. Indeed, it appears that for now, gold’s fate is tied to the performance of the dollar, which has collapsed on the back of concerns about rising US deficits, as well as the fact that major foreign central banks like the ECB are heading for the stimulus-exit door, which increases the appeal of their own currencies.

The perplexing thing about the dollar’s depreciation is that it occurred in an environment where yields on US Treasuries have risen to multi-year highs, which usually supports the currency. Despite the sharp plunge though, there are some tentative signs suggesting the currency could stabilize a little. The Fed is ever so slowly shifting to a more optimistic tone, US economic data have generally been on the strong side, and some key technical levels have held up as “lines in the sand”, helping to limit the dollar’s fall (1.2500 in euro/dollar, 108.00 in dollar/yen). Also, bearing in mind that the latest plunge appears somewhat overextended, an argument can be made that the greenback could experience a corrective rebound moving forward, before the next leg lower in the broader trend.

Besides the dollar, there is a seasonal argument to be made. In recent years, gold outperformed at the beginning of every new year, something that has been dubbed the “January effect”. Gold has risen in every January since 2014. In the bigger picture, it has gained in ten out of the last thirteen Januaries, dating back to 2006. This effect sometimes extends through February, but the average gains there are considerably lower compared to January. Although there is no consensus on what factors drive this seasonal effect, a plausible explanation is that it results from increased demand for jewelry in China and broader Asia, amid the Lunar New Year celebrations.

The bottom line here is that while gold usually outperforms in January, that effect tends to fade in February, and then, it oftentimes reverses in March. In recent years, March has been a traditionally weak month for the yellow metal, perhaps due to this seasonal demand dissipating and gold investors taking profits on their winnings.

Summing up all the above, gold’s broader direction still appears to be higher, but one should remain cautious of a near-term correction lower before the next wave up, on the back of the seasonal trade fading and a possible short-term rebound in the USD. A potential catalyst for such a rebound is tomorrow’s nonfarm payrolls report out of the US, which is expected to be on the strong side overall. Should the precious metal indeed correct lower, prices could drift towards the $1325/ounce support zone, where a potential downside break could even see scope for extensions towards the key territory of $1305.

On the other hand, in case the dollar simply continues to collapse, pushing gold higher in turn, immediate resistance may be found near the metal’s recent highs, at $1366. If buyers prove strong enough to break above that hurdle, that would mark a forthcoming higher high on the daily chart, and could open the way for the $1392 zone, marked by the highs of March 2014.