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The Wall Street correction could be great for gold

It is slightly baffling that gold has not performed better during such a historic risk-off move on Wall Street. At face value, gold ending the week lower when US equity benchmarks plummeted into a correction shows total failure as a haven. But all is not lost for gold bugs.

An inverse relationship with Treasury yields

As every man and his dog knows, Wall Street was well overdue a correction. What caused the volatility was a spike in bond yields attributed to inflation fears and an expected faster pace of tightening by the Federal Reserve. A higher rates environment is not good for gold and that made it an inappropriate destination for haven flows during this sell-off.

Gold needs markets to mistrust the central banks

There needs to be a change in the market’s perception about how central banks will react to the higher inflation for gold to really outperform. Markets are taking the Fed and other central banks like the recently hawkish Bank of England at their word. The three rate hikes from the Fed in 2017 has led market participants to think central banks will continue to hike interest rates to control inflation. Should markets start to think that central banks would back off from raising rates, even if there is higher inflation, in order to protect the global recovery then gold can be an effective inflation-hedge. The ‘Powell put’ should support gold as well as equites.

Dollar strength a burden

There is a forex market element to why gold has underperformed. The Japanese yen is bid but the US dollar looks like the biggest beneficiary of the uncertainty. While the US dollar shows signs of bottoming out against major currencies, gold will have a tough time breaking out. The US dollar had a rough year in 2017 and it makes sense to see some profit taking at the beginning of 2018. When the focus shifts back to the other global central banks drawing closer to ending stimulus, the dollar should again come under pressure, allowing gold room for recovery.

Gold thrown out with the bathwater

Gold, like other commodities was caught up in the indiscriminate selling that took place this week. It may be little consolation for those presently long gold futures, but gold has fallen much less than equities and less than oil in the past week. When there was no place to hide, gold has been one of the best of a bad bunch.

Breakout does not materialise, yet

The technical breakout above the neckline of a long-term inverse head & shoulder pattern failed to materialise this week – despite the need for a haven. In our view, while gold remains above its December 2016 low near $1120 per oz, the pattern remains intact. A drop below the December 2017 low at $1240 per oz would weaken our conviction that the break higher will materialise.


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