Gold has lost much of its glitter, ever since it peaked at $1920 in September 2011. What ensued afterwards, was a merciless bear market that pushed Gold prices to a low of $1130 in November 2014.
Harsh as this bear market might have been, there are reasons to believe that better times might be ahead for Gold, at least in the short-term. In the following paragraphs I will explain in detail, why I believe this to be the case.
Money printing accelerates
As was discussed in a previous Foresight article, central bank policy will be much more supportive than in 2014. With the European Central Bank (ECB), just having announced a €60 billion a month open-ended QE program, together with the Bank of Japan’s (BoJ) own easing measures, central bank balance sheets are set to expand at an accelerated pace (Figure 1). This at a time when the world is already drowning in cheap liquidity. In general, the expansion of central bank balance sheets have been a powerful secular trend favoring higher Gold prices, thus accelerated liquidity injections are supportive for Gold in the short-term.
Figure 1: Combined central bank balance sheet expansion set to accelerate (Source Deutsche Bank)
Extreme bond market valuations
As an alternative safe haven asset Gold has always been in direct competition with the traditional safe haven asset that is government bonds. The relentless bull market seen in government bonds over the past years has been a serious headwind for Gold.
However, valuations for government bonds have now reached totally ridiculous levels. As of this writing, US 10 year Treasury bonds are yielding only 0.875% in real inflation-adjusted terms (Treasury yield minus CPI inflation). Looking at long-term data, current inflation-adjusted yields offered for US 10 year Treasuries, are near all-time historical lows. It is worth noting that real-yields are currently lower then, during World War II and the Vietnam War (Figure 2).
Figure 2: US real yields since 1919 (Source: Credit Suisse)
The situation in Europe is even more bizarre, as over €1.4 trillion of government bonds are now trading at negative nominal yields (Figure 3)! Yes you read that correctly, over €1.4 trillion of European government bonds are considered so “safe”, that you have to pay for the privilege of lending Northern European countries your money.
Figure 3: Total amount of Euro area sovereign bonds trading at negative interest rates (Source: JP Morgan)
Currently, investors are sitting on over $2 trillion worth of bonds (Figure 4). In comparison the largest Gold ETF, the SPDR GLD Fund has only $28.4 billion in assets (as of April 2nd 2015). If only a small amount of money where to flow out of bonds and into gold, the impact would be enormous. With government bonds yielding nothing and in some cases even less than nothing, alternative safe haven assets like Gold become more attractive and the odds of money flowing out of bonds and into assets like Gold increase.
Figure 4: Cumulative flows into bonds versus historical trend (Source: Deutsche Bank)
The Federal Reserve is in no hurry to raise rates
The latest Federal Open Market Committee (FOMC) policy statement was surprisingly dovish. The most significant surprise came from the sizable downward revisions of the FOMC’s interest rate expectations, the so-called “dot chart” (Figure 5).
Figure 5: Current FOMC projections for the Fed funds rate versus previous expectations (Source: Deutsche Bank)
In layman terms, this means that the FED will start raising interest rates later and at a slower pace than was projected in December 2014. This is a bullish factor for Gold prices.
Speculative sentiment has been washed out
Gold’s short-term upside potential is reinforced by CFTC data, which indicates that fund managers are have a very low long exposure towards Gold (Figure 5). In the past such low levels of speculative positioning have coincided with short-term bottoms.
Figure 6: Net Managed Money positions in Gold futures (Source:JP Morgan)
Technicals are supportive
The technical posture of Gold, has also improved over the past few weeks (Figure 6). Gold seems to be forming a double-bottom (blue lines). The RSI indicator is also trading above 50, which indicates that Gold’ technical posture is stronger than what, one might expect on first site. The MACD indicator is also in a bullish alignment, which indicates short-term upside momentum.
Figure 7: Technical chart of Gold as of April 2, 2015
Although it is still too soon to call a long-term bottom, the current technical posturing of Gold indicates near-term upside potential.
Ways to play the market
Looking at the various fundamental, sentiment and technical indicators discussed in the previous paragraphs, I am of the view that Gold prices will trade higher in the next few weeks. Because it is still too early to know if this uptrend will last, I view this trade as a short-term opportunity and not as a long-term buy signal. Investors wanting to participate in this speculative trade, can do so thru various strategies. One strategy is to buy shares in Gold ETFs such as $GLD, $PHYS and $IAU.
Another riskier strategy is to buy shares in mining stocks, with the highest relative sensitivity to rising Gold prices. These include companies such as AngloGold Ashanti Ltd. (ticker: $AU) and Newmont Mining Corp (ticker: $NEM).
My upside target for Gold prices (in US dollars), is the significant technical resistance at $1290-$1300.
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Simon is the CEO and Editor-in-Chief of Foresight Investor. He has been following the markets passionately for over 7 years.