Gold turns positive as Italian bond sell-off gathers pace

Void of any major economic news from Europe or the US, the dollar rose further first thing this morning while stocks came under some pressure. As the session wore on though, the dollar eased back a little against safe haven currencies while European equities remained under pressure, undermined by a growing sell-off in Italian bond markets. This has been in response to Italy’s populist parties reaching a deal to govern the country together, which has raised concerns about the nation’s future in the Eurozone. As the sell-off in Italian assets gained momentum, safe haven flows started to creep into the likes of the Japanese yen, Swiss franc and even gold.  Other geopolitical factors that have helped to keep the safe havens in demand include the US-EU dispute over Iran and Israel’s controversial attack against Palestinian border protests which left over 100 people dead.

The situation in Italy helped to lift gold off the floor a little after the recent sell-off had pushed it down to a key Fibonacci-based support area of around $1285/7. The precious metal had been undermined  by the appreciating US dollar and rising government bond yields, thanks mainly to ongoing expectations that the Fed will be tightening its policy more aggressively relative other central banks in the near term outlook. This has not only been reflected in rising bond yields in the US, but also in the widening of yield differential between US bonds and those of Japan, Germany and UK. Central banks in these regions have been far less hawkish, and rightly so with economic data being mixed at best. Unless the current trend of incoming economic data – slightly strong in the US and soft to mixed bag elsewhere – changes, the dollar will likely retain its bullish momentum. However, the buck’s rally is looking a little tired and a short-term hesitation should not come as surprise.

If the dollar does pause here and given the above-mentioned geopolitical risks, gold may be able to regain its poise again. However, if it has any chance of a comeback, it will now need to reclaim that broken $1300 level and go on to push above the 200-day moving average (~$1307) again before the bulls can be tempted to get back in again. The bears who missed the sell-off might very well step back in upon a potential re-test of the broken support around that $1300 level, given the ongoing bearish trend. Thus, we will treat any gains on gold with a pinch of salt until and unless there is a clear sign of a reversal.  

From a macro point of view, next week’s light economic calendar is unlikely to cause a major shift in the dollar’s trend, so the probability of it continuing to appreciate is higher than a retracement. Thus, gold’s potential bounce could be short-lived. Among the few important data releases next week are the Eurozone manufacturing and services sector PMIs, UK CPI and FOMC minutes, all on Wednesday; UK retail sales and ECB meeting minutes on Thursday, and US durable goods orders on Friday.

Figure 1: