The Drivers of Gold; Where Are They Taking It?
The Drivers of Gold;
There are four major drivers of gold: interest rates, the USD, the USD/JPY FOREX ratio, and inflation. What happens in these huge markets matters to the price of gold since it is gold that reacts to these markets, not the other-way-around.
Interest Rates
Gold negatively-correlates with interest rates throughout the curve. Recently, long-rates (10-y and 30-y) have dropped below their upward-sloping bias channel (first two charts below), while short-rates have held steady and remain within their bias channel (third chart below).
Considering that we see the business cycle continuing to improve, and the FED likely to raise rates at least twice this year, it is reasonable to expect that long-term rates will turn back up and put pressure on gold.
The Dollar
Like rates, the USD — aside from a few weeks earlier in the spring — has a strong negative correlation with the price of gold. The question now is, will the downward trend that has been in place since December 2016 continue, or will the reality of the FED rate normalization turn the dollar higher? We tend to go with the latter, even though the USD might drop a little more before rebounding.
The USD/JPY FOREX Ratio
The USD/JPY ratio displays a strong inverse relation with the price of gold. A couple of weeks ago, the ratio rallied up through its 38% Fibonacci retrace line, but since then has corrected back down below it. Resistance is at its 50% retrace, and if it can bounce higher from there, then gold is not going too far past $1300.
Inflation
Inflation, as measured by the non-governmental Pring inflation index, has a very strong positive correlation with gold. Since the beginning of 2017, however, the correlation has been negative, as gold moved higher while inflation fell. We expect the correlation to revert-to-the-mean, and since inflation is not a threat at present — thanks to the expected FED rate hikes — a drop in the price of gold will likely be the cause the reversion.
In conclusion, three of gold’s drivers — rates, the USD, and the USD/JPY ratio — are neutral-to-positive, while the fourth driver — inflation — is neutral-to-bearish for gold. We think gold could still rise marginally over the next week, but we expect the longer-term trend to be down for gold as it reverts to its correlation mean.
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