Gold Breakout - What to Watch
The gold price has staged a strong rebound off its May 5th low print of $1,462 and is now trading within 2.5% of its all-time high of $1,578 per ounce. Gold futures and options positions on the COMEX rose for the first time in five weeks with net long futures positions rising 7%. It is worth considering what might signal that a sustainable breakout in gold is forthcoming. The following should be closely monitored in coming weeks:
All of the above, if achieved, would usher in a more bullish backdrop for gold prices and would likely lead to a significant breakout. However, if the preceding does not materialize, then the resulting bearish divergences would point to a deeper correction. The current rebound in gold could then be considered a countertrend move and new correction lows would be likely.
Impact of Greek Crisis on Gold
With credit default swaps on Greek debt blowing out to fresh record highs last week, it is worth pondering the implications of a Greek default. Last week, the International Monetary Fund (IMF) warned that it may not continue funding Greece if the Hellenic Republic cannot guarantee financing for the next 12 months. Of greater importance than a default, or partial default (re-structuring), by Greece is the broader impact on the European Central Bank (ECB). The ECB has billions of dollars of low-quality securities, including Greek debt, on its balance sheet.
While the ECB and leaders across Europe have thus far been able to kick the can down the road, a Greek default would call into question the integrity of the ECB. Given that the same structural issues facing Greece exist in Portugal, Ireland, and Italy, confidence in the euro could vanish rather quickly.
Given that gold is a monetary asset, the long-term implications on the yellow metal are decidedly bullish. Both individuals and central banks would likely increase their allocations to gold due to the fact that it is the one currency with no political liabilities behind it. The central banks of emerging nations have already displayed a penchant to hold a greater percentage of their foreign exchange reserves in gold. Falling confidence in the euro would likely exacerbate this trend and provide a strong tailwind for gold prices.
Be Careful What You Wish for
Despite the positive long-term implications, over the shorter-term a sinking euro could be bearish for gold - as well as nearly every asset class. A currency crisis would likely lead to deleveraging in financial markets. As was clearly evident from the 2008 experience, selling begets selling and quality assets are liquidated alongside junk. Investors in gold exchange-traded funds, such as GLD, as well as gold stocks would likely sell in a rush to cash. The U.S. dollar would rally and, in the midst of a wave of deleveraging, gold could move lower.
Gold bulls calling for a steep drop in financial assets as a currency crisis unfolds should be careful what they wish for.
The gold price has staged a strong rebound off its May 5th low print of $1,462 and is now trading within 2.5% of its all-time high of $1,578 per ounce. Gold futures and options positions on the COMEX rose for the first time in five weeks with net long futures positions rising 7%. It is worth considering what might signal that a sustainable breakout in gold is forthcoming. The following should be closely monitored in coming weeks:
- Are the gold mining stocks confirming a breakout in gold? Is the Market Vectors Gold Miners ETF (GDX) making a lower high, thereby creating a bearish divergence?
- Is the silver price making a lower high? If gold's sister precious metal is unable to climb to a new high, the intermediate-term outlook for both gold and silver would deteriorate markedly.
- Is the silver/gold ratio able to move to fresh lows? A move below 30 in the silver-gold ratio could usher in fresh speculative money flows into both precious metals.
All of the above, if achieved, would usher in a more bullish backdrop for gold prices and would likely lead to a significant breakout. However, if the preceding does not materialize, then the resulting bearish divergences would point to a deeper correction. The current rebound in gold could then be considered a countertrend move and new correction lows would be likely.
Impact of Greek Crisis on Gold
With credit default swaps on Greek debt blowing out to fresh record highs last week, it is worth pondering the implications of a Greek default. Last week, the International Monetary Fund (IMF) warned that it may not continue funding Greece if the Hellenic Republic cannot guarantee financing for the next 12 months. Of greater importance than a default, or partial default (re-structuring), by Greece is the broader impact on the European Central Bank (ECB). The ECB has billions of dollars of low-quality securities, including Greek debt, on its balance sheet.
While the ECB and leaders across Europe have thus far been able to kick the can down the road, a Greek default would call into question the integrity of the ECB. Given that the same structural issues facing Greece exist in Portugal, Ireland, and Italy, confidence in the euro could vanish rather quickly.
Given that gold is a monetary asset, the long-term implications on the yellow metal are decidedly bullish. Both individuals and central banks would likely increase their allocations to gold due to the fact that it is the one currency with no political liabilities behind it. The central banks of emerging nations have already displayed a penchant to hold a greater percentage of their foreign exchange reserves in gold. Falling confidence in the euro would likely exacerbate this trend and provide a strong tailwind for gold prices.
Be Careful What You Wish for
Despite the positive long-term implications, over the shorter-term a sinking euro could be bearish for gold - as well as nearly every asset class. A currency crisis would likely lead to deleveraging in financial markets. As was clearly evident from the 2008 experience, selling begets selling and quality assets are liquidated alongside junk. Investors in gold exchange-traded funds, such as GLD, as well as gold stocks would likely sell in a rush to cash. The U.S. dollar would rally and, in the midst of a wave of deleveraging, gold could move lower.
Gold bulls calling for a steep drop in financial assets as a currency crisis unfolds should be careful what they wish for.
KEY UPCOMING CATALYSTS FOR GOLD The most anticipated economic report of the month comes Friday when the May unemployment report is announced. A Bloomberg survey of economists shows expectations are for a gain of 185,000 nonfarm payrolls. The unemployment rate is forecast to drop 0.1% to 8.9%.
A weak employment report, combined with last week's downward revision to first quarter GDP, will keep Chairman Bernanke and the Fed firmly in the dovish camp. Monetary policy remains a tailwind for the gold price and as long as the labor and housing markets continue to show very little improvement, surprises in the gold market should be to the upside.
A weak employment report, combined with last week's downward revision to first quarter GDP, will keep Chairman Bernanke and the Fed firmly in the dovish camp. Monetary policy remains a tailwind for the gold price and as long as the labor and housing markets continue to show very little improvement, surprises in the gold market should be to the upside.
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