Gold has been a strong performer since the beginning of the year, rising about 6.2% compared to a roughly 6.5% decline in the S&P 500. With central banks implementing extraordinary monetary policy following the 2008 economic crisis, investors bought gold on the premise that it would be both a safe haven and inflation hedge. The subsequent lack of inflation – and ongoing threat of deflation – helped precipitate its dramatic fall.
While gold remains in a bear market, there are a number of factors in play that could impact prices over the coming year. The big question on the minds of investors is whether the recent move higher could be the start of something much bigger.
Mixed Fundamentals
Gold’s value depends on a combination of jewelry, investment, and industrial demand, as well as a resurgence in its utility as a reserve currency of sorts.
Gold demand for jewelry has been surging in the U.S., thanks to the higher value of the U.S. dollar that makes it cheaper for consumers. In key markets like China and India, demand also remained robust throughout most of last year. The Indian government has even introduced a scheme to monetize the gold stocks held by its citizens, which are estimated to be around 22,000 tonnes. This could bolster demand. Europeans have also remained steady buyers.
From an investment perspective, the outlook on gold has become bearish due to rising interest rates in the U.S., which increases the opportunity cost of holding a nonyielding commodity. These dynamics have been partially offset by investors using gold as a hedge, given the unprecedented equity market volatility. The former may have a longer-term impact, while the latter may have a shorter-term impact on gold prices moving into the new year.
The market has also been impacted by global central banks. In particular, the People’s Bank of China has tripled its holdings of gold bullion since April of 2009 to 3,610 metric tons. This in an effort to set itself up as a reserve currency. Russia was also a significant buyer of gold in the aftermath of the 2008 economic crisis. The idea is that the physical gold holdings are more credible in the world’s eyes than fiat currency – especially without stable economic backing.
Technical Crossroads
Gold prices are at a crossroads from a technical standpoint, trading just below its 200-day moving average of $1,132.50. With a Relative Strength Index reading of 65.02, the commodity appears to be overbought in the short term. However, a rising moving average convergence-divergence (MACD) indicator points to a bullish move that still has legs. Prices have moved slightly past the 200-day moving average in the past, but have quickly reversed directions in both cases.
Traders should watch for a few things over the coming months:
- A significant and sustainable break above the 200-day moving average.
- A crossover of the 50-day moving average above the 200-day moving average.
- A sustained breakout from trend line resistance at around $1,225.
The Bottom Line
Gold prices have rebounded nicely from their lows in late 2015, but there are some conflicting dynamics at play. On the one hand, rising U.S. interest rates increase the opportunity cost of holding nonyielding gold assets. On the other hand, rising demand and the potential use of gold as a hedge against volatility have increased its appeal. That said, traders should watch for a breakout from $1,225 before calling the current turnaround the start of a bull market.
