Gold has remained steadfastly range bound through early 2018. Low volatility has prevailed as markets await interest rate decisions by the Fed, confirmation on medium term inflation trajectories, and whether the political static heard around several global hotspots refines into a sharper and more combative tone.
A market lulled into complacency is often a good time for traders to explore opportunities. The key question to research now is, when will we see a sharp move in the price of gold?
We encourage gold traders to closely monitor several indicators to craft an outlook, which we look at below. They include:
- Recent price action
- Gold price volatility
- The Federal Reserve and interest rate expectations
- The relationship with the US Dollar
With a closer look at those factors, we can better understand how the current rage was built, and what might move markets out of it.
Gold Price Movement Last Week
The price of gold snapped a several week streak of higher weekly closes last week as geopolitical tensions drifted away through the back half of the week and the dollar strengthened.
Lately, the dollar has also seen a mild surge of support further exposing the price of gold to downside movement. A rising dollar can mute short term momentum for gold prices. In the long run, a stronger dollar could be bearish for gold. Making the dollar a more attractive asset was a steep rise in U.S. Treasury yields and U.S. Treasury yields were constructive to a rise in the dollar all week. U.S. 2-Year Treasury yields reached 2.453 percent on Friday, the highest level since September 2008.
Gold is sensitive to moves higher in both bond yields and the U.S. dollar. A stronger dollar makes gold more expensive for holders of foreign currency, while a rise in U.S. rates lifts the opportunity cost of holding non-yielding assets such as bullion.
chart built in TradingView by Jason Pfaff
Gold Price Volatility
It's an understatement to say volatility has been tepid as of late. For the first almost four months of the year, Gold has stayed in roughly the same 50 point range. Long considered a preeminent safe haven asset, the price has mildly ebbed and flowed as geopolitical tensions have remained dynamic, but there has been no meaningful shift in the underlying direction for sometime now.
A leading indicator for a sharp move out of the current range would be an uptick in volatility.
chart built by Jason Pfaff in TradingView
Gold and The Federal Reserve
As inflation has accumulated incrementally more structural support, we have seen a lid on pricing for gold in the neighborhood of 1350.
The broadly held market expectation is for at least 3 rate hikes total in 2018, and there has been a slow swelling of conjecture lately that there could be four. A review of the dot plot, which is the Federal Reserve's own indication of internal interest rate expectations, demonstrates incremental moves higher in rates over the next two years.
The Relationship Between the Dollar and Gold
Over long stretches of time, the price of gold and the dollar have shared an inverse correlation. Generally, as one moves up, the other moves down. A stronger dollar makes gold more expensive for those buyng in other currencies. Further, if rates and the dollar are rising in value, this translates to a growing opportuntity cost inherent in holding gold. Because it does not yield a return based on a change in rates, like a bond would, this means as returns are more attractive elsewhere, gold loses some luster.
The chart below demonstrates that going back to last fall, the dollar, as represented by the candlesticks, has lost value relative to its peers in the forex markets. At the same time, gold, represented by the purple line, saw a sharp rise in value and has since steadied in its current range.
Both assets have stabilized at current levels and are grinding sideways.
chart built by Jason Pfaff in TradingView
We recently undertook a deep and exhaustive mathematical analysis to isolate and better understand the variables that might be influencing the price of gold in the current marketplace.
The variables analyzed included:
- Gold Price Volatility
- The spread between the ten year and two year interest rates. This spread s often a way to calculate the markets expectation of growth and/or a recession.
- The SP 500
- The DXY dollar index
Through an ensembled set of regression models built on data since 1973, we determined the relative importance of each variable, as shown in the chart. Half of the change in price over time correlates to movement in the DXY.
Based on this analysis, we built a machine learning model based on an architecture of deep learning neural networks, time series based regression and moving averages, and exponential smoothing models. We forecast a variety of market scenarios for each variable, and brought the full picture together to build a forecast for the next 200 days for the price of gold.
Over the next 200 days, we envision the price of gold remaining in a range primarily between 1400 and 1500. Within that range there are a series of relatively sharp moves, primarily attributable to shifts higher in interest rates and the valuation of the dollar. Countering this is continued uncertainty in the geopolitical realm, which is constructive to the price of gold.
A complicating factor will continue to be the DXY and the overall outlook for the dollar. In short, the road ahead for the dollar presents a mixed picture. Given the extended moves higher in interest rates and modest growth domestically, we see some basis for a mildly bullish outlook for the dollar. However, with the dramatic growth in government issued debt, and an uncertain domestic policy picture, we also see several possible narratives which could weaken the dollar. In summary, this leads to a choppy and mixed outlook for the dollar and the DXY index, which calls for an extension of the range for gold that markets are currently trading within.
Risks to this outlook include a meaningful shift in the geopolitical landscape which could occur at any time, or a change in the current rate path, which is less likely.
Ultimately, we see an elevated probability for a contination of the current range with an incremental move towards the $1500 level as the 200 day window comes to a close.
mathematical models, analysis and chart built by Jason Pfaff in R from historical data via St. Louis Federal Reserve