Gold loses its shine – For now

The drop in the gold price over recent days has been dramatic. It is no coincide that it has occurred at a time when the US dollar is consolidating and real yields have increased again. Gold buying had accelerated over recent weeks, resulting in a sharp and what has proven to be, an unsustainable rally. The subsequent drop in gold prices (around 9% from its peak around $2075) may yet turn out to be a healthy correction from overbought levels amid heavy positioning.  However, in the near term it is not advisable to catch a falling knife, with some further weakness likely before any turnaround.

Prospects for gold further out remain upbeat despite the current correction. Continued ultra easy monetary policy from the Fed and other major central banks, likely persistent low real bond yields amid central bank bond buying, continuing virus threats and importantly ongoing pressure on the US dollar, all suggest that the correction in gold prices will be met by renewed buying for an eventual upward test of $2000.  However, in the near term the pull back in gold likely has more room, with the 61.8% Fibonacci retracement level around $1835 and the 50 day moving average around $1829 important support levels.

As noted, it is no coincidence that that the dollar has strengthened at the same as gold has collapsed. The dollar has looked increasingly oversold both from a positioning and technical perspective and was due for a correction. Whether the correction in the dollar can turn into a sustainable rally is debatable, however. Unless there is a sustainable turn in real yields higher or signs that the US economy will move back to outperforming other major economies, it seems likely that the dollar will struggle to recover, especially ahead of US elections and all the uncertainty that they will bring in the next few months, especially if the result of the elections is a contested one.

Another trend that is taking shape in markets is the rotation between momentum and value stocks. Recent market action has shown a marked underperformance of tech stocks relative to value stocks. Stocks that benefit from re-opening are increasingly in favour though their performance is still far behind that of tech stocks over recent months.  Much still depends on how quickly the virus can be bought under control, which in turn will signify how well re-opening stocks will do going forward. There are encouraging signs in the US that the pace of increase is slowing but it is still early days and as seen globally the virus is hard to suppress.