- Weak USD and inflation fears sparked best bull run since 2011
- Funds chased gold higher after record dump in December
- Gold may be aiming for key resistance between $1350 and $1375/oz
The bull run has been fun, but is there more to go? Pic: Shutterstock
By Ole Hansen
Dollar weakness and raised inflation expectations following the December 12 US rate hike and US tax deal have supported the best run higher in gold since 2011. Funds have been chasing the market up after dumping a record amount of gold in early December.
Following the strong sprint during the final couple of weeks of 2017, gold managed to finish more than 12% higher on the year. One of the biggest surprises of the year was the dollar, which against an index of major currencies saw the biggest decline since 2013. The 10% decline in the DXY helped to explain the bulk of gold's performance but it nevertheless managed to attract additional demand despite record stock market valuations and surging demand for crypto currencies.
Despite the succession of US interest rate hikes, US ten-year bond yields finished the year close to where they were when it began. Breakeven yields, which reflect inflation expectations, finished the year at close to 2% following a late rally which was driven by the US tax reform and its potential inflationary impact. As a result of these developments, the opportunity cost being the real yield relative to the non-coupon and non-interest paying gold, stayed within a relatively tight range all year.
Five consecutive US rate hikes have so far all helped create local lows from where gold managed to recover strongly. The December 12 rate hike was no exception with the timing marking another low point from where it has so far managed to rally by more than 5%.
The price weakness seen in the run-up to the December 12 rate hike together with nervousness about the growth and yield impact of the pending US tax reform helped trigger record selling of gold. During a two-week period up until December 12, hedge funds sold 124,000 lots thereby cutting the net-long by 60%.
In the following two weeks up until December 26 only 30,000 lots where net-bought with the bulk coming from short-covering. A continued rally is therefore likely to attract additional buying from funds finding themselves under-invested, either through direct exposure to gold or through demand for commodity index funds where gold contributes between 5 and 12 percent of the total exposure.
Total holdings in exchange-traded products backed by gold rose by 230 tons last year to 2234 tons which is close to the highest level in almost five years. Investors seeking protection against corrections in stocks from record levels and key government bonds from near-record low yield levels helped provide underlying demand. This happened despite the volatility being provided by hedge funds continued adjusting of positions as seen in the chart above.
At the beginning of 2018 we see no reason why this underlying demand should not continue. The dollar could face further weakness, stocks are elevated and bond yields are low and with that comes the risk of corrections. One of gold's best friends – Donald Trump – continues to preside over an unpredictable US administration while emerging inflation is likely to add an additional layer of support.
Incendiary tweets like this send investors rushing into safe havens. Source: Twitter
Gold has been trading sideways for the past four years and the December rally which occurred well ahead of support at $1200/oz means the market could once again be attempting a move towards the key area of resistance between $1350 and $1375/oz.
The almost non-stop rally since December 12 has only yielded small corrections with the biggest being today's 10 dollar top to bottom move. In the short term, however, a read above 70 on the 14-day RSI has raised the risk and likelihood of a pullback. Using Fibonacci the first level of support can be found at $1289/oz. which is in line with the 100-day moving average.
– Edited by Clare MacCarthy
Ole Hansen is head of commodity strategy at Saxo Bank