Commodities

Gold rips higher amid a quiet flight to safety – Special Report

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Bullion prices continue to surge, ascending to fresh 10-month highs this week. Since the correlation between gold and the US dollar has diminished lately, it seems a flight to safety is quietly going on, amid global growth and recession concerns. Yet, for buyers to pierce above the elusive $1365 area, some more ‘fuel’ may be required, such as a fresh escalation in growth risks or a materially weaker dollar.

Gold has had an impressive run so far this year, rising by 4.7% in less than two months. The precious metal’s gains can be tracked back to two main factors: the Fed’s dovish pivot, and safe-haven demand as investors seek a hedge against a myriad of risks, with a slowdown in global growth topping this list.

Fed turnabout

Let’s start with the Fed, which in a surprising deviation from its earlier signals, recently announced it will hit the ‘pause button’ on future rate hikes while it monitors the health of the US economy. Rising interest rates typically hurt precious metals like gold, as the ‘opportunity cost’ of holding them increases. Remember that bullion not only pays no interest when holding it but also carries storage costs. Thus, as rates rise, other interest-bearing assets – like bonds – start looking much more attractive in comparison. In this logic, the Fed’s signal that it won’t raise rates any further, for now at least, increased the yellow metal’s appeal.

Seeking shelter

Then, there are the growth concerns and the flight to safety. Economic data have been losing momentum across the globe in recent quarters, from the US to China to the UK, though the weakness is perhaps most evident in the Eurozone. This has led both investors and policymakers to start considering worst-case outcomes, such as an outright global recession.

In fact, as pictured above, the probability for a US recession by early 2020 has been rising steadily recently and now rests at 23.6%, according to New York Fed models. Regardless of whether a slump will actually happen or not, the mere fact that expectations for a downturn are growing is enough to fuel demand for haven assets.

What makes gold’s winning streak particularly impressive, is that the US dollar index is also marginally higher year-to-date (+0.4%). Usually, these two assets have a strong negative correlation, meaning that when the greenback gains, gold loses – and vice versa. This stems from the fact that gold is denominated in dollars, so when the US currency strengthens, it becomes more expensive for investors using foreign currencies to buy bullion, dampening its demand.

Therefore, gold has been outperforming this year even despite a slightly stronger dollar applying downward pressure on it. This fading correlation between the two confirms that investors are buying gold for reasons other than movements in the dollar, like increasing defensive exposure.

More fuel

While the medium-term outlook for gold is clearly positive, the speed and magnitude of the recent gains suggests some cause for caution, as most of the aforementioned risks are likely reflected in the price by now. This implies 1) that the risk of a corrective pullback in the immediate term may be elevated and 2) that for the bulls to break above the 2018 highs around $1365 in a sustainable manner, some fresh catalyst may be needed. Either a further escalation in market growth concerns, or a significant drop in the dollar, or both. Of course, there are several risks in the political arena that could also do the trick, the most notable being a disorderly Brexit.

The technical picture is equally positive, as gold prices are posting higher highs and higher lows above a medium-term uptrend line drawn from the lows of November. Additionally, the 50-day simple moving average (SMA) has crossed back above the 200-day one, which is a bullish signal. Another wave of advances in prices could encounter resistance around the $1355 level, marked by the May 19 peaks. Even higher, the bulls could stall near $1365.

On the flipside, a corrective pullback may find immediate support at $1326, which halted the rally on January 31. A downside break would shift the attention to the crossroads of the $1302 zone and the aforementioned uptrend line. If the bears manage to violate that area too, that would shift the technical outlook back to neutral.