The latest attempt for gold prices to rally higher was quickly cut short as the rebound in the dollar sapped demand for the barbarous relic. Understanding the diverging interest in precious metals is not as simple as dividing the globe with a line splitting East from West. There is a confluence of factors contributing to the persistent weakness in dollar-denominated gold prices even though global physical demand remains robust.
Physical Accumulation Unrelenting
Western Central Banks have seen gold reserves stay relatively unchanged over the last few years while rising Eastern powers and emerging economies have been keen to add gold to Central Bank reserves at a frenetic pace. While Central Banks of Western powers have been acutely focused on reducing retail demand for gold by pushing fiat currency, Eastern nations have a strong historical tendency to purchase gold, especially in India and China. The Middle East also remains a major source of physical demand due to cultural ideology which emphasizes hard assets.
Central bank demand is one important component of prices as it typically accounts for large volume purchases. However, the retail component should not be underestimated. India’s move to lift restrictions on gold imports in February has seen a revival in official demand with local companies importing at a record pace. Gold in India which has traded at a premium of upwards of 25% to London spot rates, remains highly sought after. Demand is so strong that India’s largest Jeweler, Rajesh Exports, is seeking to vertically integrate operations by buying gold mining operations to ensure it has a steady supply of gold, the first move of its kind in the jewelry industry.
Inflationary Backdrop Weak
The persistent deflationary forces circling the globe are setting the stage for continued losses in gold prices despite the strong demand characteristics for physical bullion. Gold typically serves as a resilient hedge against losses in purchasing power vis-à-vis fiat currency, making it an attractive way to prevent wealth erosion. However, with inflationary metrics across the globe just barely positive, economies experiencing disinflation, or nations already trending in the throes of deflation, there is little reason to run to gold to hedge against fiat currencies. UK inflation released earlier in the week showed that annualized inflation is unchanged at 0.00% while European economies are deeper in negative territory with Italian annualized CPI at -0.10% and Spanish CPI for a similar period at -0.70%. Aggregate figures due from the Euro Area are expected to show the number trending at -0.10% year over year.
The United States is also witnessing minimal inflation expansion, with Friday’s comparable CPI release forecast to print at a 0.10% annualized pace. Although inflation is expected to rebound based on a recovery in energy prices, without this driver, inflation may remain well below the Federal Reserve’s longer-term target of 2.00%. Until the Federal Reserve is confident that inflation expectations have become more firmly anchored and will resume trending towards the 2.00% objective, the FOMC is unlikely to raise interest rates, slowing the rapidity of the dollar’ ascent.
Inverse Correlation To Dollar Strong
The dollar has hit a few road bumps in recent months as the rate outlook gradually shifted further towards the end of 2015 or beginning of 2016 despite calls from certain hawkish FOMC members to hike interest rates sooner. XAU/USD, or dollar-denominated gold, has been extremely responsive to movement in the dollar owing to the strengthening inverse correlation between the two assets. Healthy physical demand numbers from India slightly upset the inverse correlation late last week, but the relationship quickly reverted as the dollar trumped other fundamental factors driving gold valuation.
From a technical perspective, the near-term and longer-term charting patterns suggest a continued bearish bias in precious metals especially after the latest bounce in gold prices on the back of dollar weakness failed to overcome January’s highs above $1300 per troy ounce. The longer-term descending triangle pattern coupled with a medium-term head and shoulder’s bearish pattern indicates that gold trading strategies should be focused on combining the fundamental and technical factors at play. Fading rallies in precious metals should be the prevailing tactic employed to take advantage of near-term volatility in prices unless dollar momentum abates and the US Federal Reserve pivots towards more dovish, accommodative monetary policies.