Article / 25 May 2016 at 11:17 GMT

Gold can ride out Fed, dollar challenges

Head of Commodity Strategy / Saxo Bank
  • Gold slipping towards $1,200/oz as dollar strength, hawkish Fed weigh
  • Gold support at $1,175/oz, but $1,145/oz could mark a turning point
  • Long-term outlook still favours upside despite current blip
Hawkish Fed rhetoric is directly impacting the gold price. Photo: iStock

By Ole Hansen

Precious metals have been rocked in recent days by the increased hawkish rhetoric from several Federal Open Market Committee members. As a result of this we have seen interest rate projections once again being raised and the dollar has benefited from these developments.

While initially causing some concerns across other asset classes such as stocks, yesterday's price action signaled a bit of a change, described here by Saxo's forex chief John Hardy in his daily FX Update.

"Yesterday looked like a key reversal for markets, as the blatant risk-on move felt like the market making some kind of declaration. The timing is important as we have just seen a cavalcade of Fed speakers talking up the Fed rate trajectory this year. That hawkishness had engineered a sharp rise in short US interest rates that took the USD higher, especially against risky currencies, and had put risk appetite on the defensive. But then yesterday’s action seemed to proclaim that the market may not be so afraid of the Fed’s hawkish stance after all."

The risk-on in stocks and the continued support for dollars combined with rising bond yields have all helped create a challenging environment for precious metals, not least gold. And for the first time since the strong rally began back in January, questions have arisen about the sustainability of the rally and gold's ability to find support. 

A pickup in bond yields and the stronger dollar have created a strong challenge to gold's resolve
Fundamental Gold drivers
Investment demand for gold, especially through exchange-traded products, has remain solid this month, at least up until yesterday where a small reduction was seen. Total holdings during this time have nevertheless risen by almost 5%, while the price of gold has fallen by 5.5%.

Investors have in other words viewed the price weakness as an opportunity to accumulate exposure in the belief that the long-term direction remains to the upside. 

Gold demand up in ETPs, price down
Gold ETP demand up price down
Hedge funds using futures, on the other hand, may be the main culprits behind the recent selling. The positions held by this group of investors are most likely to have tight stops and with no underlying exposure to hedge, they add and reduce positions in accordance with market behaviour.

During the first week of May they increased the net-long futures and options position by 26%. With just a few changes seen during the proceeding two weeks, these positions are now under water, and adjustments are likely to have occurred.

After breaking the channel from February yesterday, the attention now turns to the major retracement levels. In order for this to be nothing but pro-trend, correction support needs to be established preferably ahead of $1,205/oz. A deeper correction to $1,175/oz will still be ok while a return to $1,145/oz will signal a return to the drawing board for fresh guidance. 

XAUUSD was at $1,220.98/oz at 1108 GMT, according to SaxoTraderGO.

Spot gold with retracement levels
Source: SaxoTraderGO

Options traders have increasingly been casting their focus on call options during the current selloff. It does indicate that while the search for support continues, some traders prefer to express a bullish opinion through options.

The four most traded options on Comex gold futures during the past week are all calls.

Top ten most traded options strikes
While US interest-rate expectations are being adjusted higher and the dollar continues to recover, gold will be struggling. However low growth, negative sovereign-bond yields, the potential of inflation making a rare return and upcoming event risks make us view the current setback as a healthy correction within the established uptrend.

— Edited by Martin O'Rourke

Ole Hansen is Saxo Bank's head of commodities strategy


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