2023-05-12 09:40:50 ET
Summary
- After a huge rally, gold faces its biggest challenge of the year.
- The strengthening dollar threatens to upend the yellow metal.
- Economic worries and financial market volatility are giving the greenback a boost at gold's expense.
It has been a major roller coaster ride for gold investors over the past 14 months. From just shy of an all-time peak early last year, the yellow metal was crushed by the resurgent dollar for much of 2022, and the price ultimately fell 22% before bottoming at $1,625 an ounce in October. But gold's fortunes changed dramatically at the end of the year, and most of the ground lost during last year's slide has since been recovered.
Now that gold is within reach of a new record high, it's time to evaluate its short-term prospects for continuing the bull market that began last November. The gold bulls are trying to consolidate their recent gains as the gold price tightens up under the key $2,050 level. But gold's biggest enemy in recent years-namely the U.S. dollar index-is threatening a rally of its own and will soon provide gold with a major test of strength.
As gold is priced in dollars, a strong greenback is typically bad news for gold bulls since it provides a major headwind for the precious metal. Gold's currency component has taken on special significance in recent years due to the increased attractiveness of the dollar as a safe haven among foreign investors-especially since 2020.
While there have been times over the last few years in which both gold and the dollar have managed to rally in tandem, the normal relationship between the two is inverse in nature. That is, a rising dollar index typically means a falling gold price, and vice-versa.
This inverse relationship is illustrated in the following graph which compares the progression of my favorite gold-tracking ETF, the GraniteShares Gold Trust (BAR), with the dollar-tracking Invesco DB U.S. Dollar Index Bullish Fund (UUP). Clearly the tendency has been for gold to benefit from the dollar weakness that has been the dominant trend for most of the last nine months.
BigCharts
The dollar fell into weakness last year shortly after the 10-year minus 3-month U.S. Treasury yield curve inverted (below). This was a telegraphed signal to investors around the world that the U.S. economy was becoming vulnerable to a recession. As a nation's currency is nothing if not a reflection of the strength of its economy, the yield curve inversion served as the catalyst for a massive tradeoff of dollars for an even bigger safe haven.
This is where gold entered the picture. Indeed, the metal is widely regarded as the ultimate haven asset to own in troubled times due to the metal's historical ability to maintain value through periods of economic, social and political turbulence.
Gold subsequently soared to within reach of its previous all-time high, just under which it stands as of this writing. However, the dollar ETF (shown below) is strengthening in the face of the increasing selling pressure in the bank stocks. It looks as though international investors are once again liquidating risk assets and turning to the perceived safety of cash, which in turn is boosting the dollar's value.
BigCharts
Technically speaking, if UUP closes this week (May 12) above the 28 level it will send a confirmed intermediate-term breakout signal. In doing so, UUP will have made it above its psychologically significant (and widely watched) 50-day moving average for the first time since February. This in turn would likely catalyze additional short covering, as there is enormous bearish sentiment on the dollar right now. (A case can be made that an explosive dollar rally is imminent based solely on this contrarian principle of too much negative sentiment on the greenback.)
What's more, as was the case with the dollar's last rally in February, gold would likely turn south as a result of it. In the most recent dollar rally, gold shed 7% in just four weeks. For the GraniteShares Gold Trust ETF shown here, a violation of the 50-day line at 19.50 would confirm that the gold bulls have lost control of the metal's intermediate-term trend.
BigCharts
While it's possible that gold can hold its own in the face of dollar strength, it's more likely than not that the metal will give back at least some of its recent gains. Indeed, given the extent of gold's runup in the last two months (up 13% between March and early May), a sharp pullback would make the most sense.
In view of the increasing potential for a dollar rally, I'm recommending that gold investors book some profits after the metal's recent rally and raise stop-losses on intermediate-term trading positions. Ongoing equity market volatility, meanwhile, will provide more impetus for investors to move to the dollar vis-à-vis gold since the former is "oversold" while the latter is arguably "overbought."
For further details see:
Big Test Coming Up For Gold