It’s been a frustrating few months for Gold traders. After rallying strongly into the closing trading of last year, the yellow metal failed to continue its bullish momentum this year and has spent 2018 in a stagnant block of sticky price action. The reason for this has been the conflicting forces at work in the market which have made it difficult for traders to get a handle on gold’s direction.
Gold Caught Between Conflicting Forces
With the Fed having reaffirmed its commitment to raising rates and the economy seemingly back on track, gold has been under selling pressure from those anticipating a stronger US Dollar. However, the path has not been an easy one and gold has consistently seen demand kicking back in as the US Dollar has suffered from political uncertainty linked to President Trump. Trump’s policy blunders at the start of the year with healthcare poured doubt on the market expectation that the President was going to storm ahead with the policy proposals outlined during his campaign, most notably the massive infrastructure spending program that has yet to materialise.
Alongside this, we’ve seen a great deal of uncertainty (especially over the last month) linked to US trade policy. The President’s increasingly protectionist stance, especially towards China has caused a great deal of uncertainty in the market and a flight to safety which has kept the safe-haven gold propped up.
USD Short Squeeze In Full Swing
Over recent weeks however, the US Dollar has been moving higher with conviction which has weighed on gold over the last week. Given that USD short positions (as shown by the COT report) have been at their highest levels for five years, there is plenty of room for a further short squeeze.
The current short squeeze has been exacerbated by the rally in short end yields and their subsequent impact on USD hedging costs. With 3 month one year forward USD swaps having risen 0.20% this month, USD hedges have suddenly become very expensive to hold, hence the exodus we’ve seen so far.
Will USD Rally Continue?
The question now is whether this USD rally continues or if it rolls over and allows gold to come back up for air. Of course, the longevity of this rally relies on the broader fundamental picture. If the rally does continue, we can expect gold to track the move lower given that the yellow metal is currently showing a nearly 80% correlation with USD this year, marking the strongest relationship between the two since 2008.
Key focus this week will of course be on the Fed who are due to meet on Wednesday for their May rates meeting. While the Fed is not expected to move on rates, following last month’s 0.25% increase, traders will be keen to receive the bank’s latest inflation forecast given that PCE inflation (which the Fed tracks closely) was back up to 1.9% in March. If the Fed lifts its forecast, this is likely to further extend the USD short squeeze we are seeing, and weigh on gold.
After stalling at the 61.8% retracement from the 2014 lows, USD has since formed a base and moved higher. The index is now challenging an important resistance level at the retest of the broken 50% retracement and also the broken September 2017 low. If USD stays above here we are likely to see further movement higher with a retest of the broken long term bullish trend line coming into focus.
After pushing up to a fresh 2018 high a few weeks ago, Gold prices have since reversed and traded sharply lower. The yellow metal is now challenging the supporting trend line of the broader contracting triangle pattern which has framed price action over the last two years. If price breaks this level the deeper 1296.65 structural support will come into play.