Gold's moment to shine

Unlike many other commodities, gold has made significant gains in recent months. So, what's driving the rally and how far can it go?

Commodity markets have recently seen investors and traders engaged in the dispiriting business of adjusting their expectations ever lower as fresh price support levels are broken with alarming frequency.

Perhaps surprisingly, gold is one commodity where traders have the opposite problem at the moment. They are now contemplating the possibility of a break through chart resistance to build on the significant gains made since early November. The yellow metal is now about 8.7 per cent above its November low.

This rally has occurred in the face of an economic background that might normally be seen as bad news for gold. Declining inflation expectations have removed one of the underpinning reasons for investing in it, while the US dollar, in which gold is generally quoted, has been rising. The fact that gold has risen alongside the rallying US dollar means that the gold price is now up in all major currencies. This usually suggests significant underlying strength. Quoted in euros, for example, gold is up 14.3 per cent from its November low, while in the Aussie dollar terms, the gold price is up 15 per cent.

So what’s underpinning this recovery? Here are a few factors that could be in play:

  • Paradoxically, the big drop in oil prices is likely to be a key driver in the demand for gold. It has raised real concerns about the Russian economy and a crash of the rouble. It’s not hard to imagine that Russians have been buying gold as a hedge against wealth destruction. Indeed the Russian central bank was a significant buyer last year. The latest figures show this continued in November, with the bank purchasing nearly 19 tonnes to bring total holdings to 1,188 tonnes.
  • Markets are again becoming concerned about the fragility of Europe, with growing speculation that Greece could exit the eurozone.
  • Quantitative easing by the European Central Bank could be bullish for gold. Lower bond yields will see investors seeking alternative risk assets. With industrial metals and oil facing supply issues, gold may be seen as a more attractive alternative.

So while these concerns have been supportive for gold in recent months, traders are now considering whether this will be enough to push gold higher in the face of persistent low inflation and the possibility of further long-term gains in the US Dollar.

Indeed, gold may have arrived at a watershed zone. As the weekly chart below shows, the gold price has recently formed an inverse head and shoulder pattern. This is one of the classic bullish reversal patterns. However, it’s not completed until the price breaks through the neck line and small false breaks are common. For this reason many pattern traders like to see a break well clear of the neck line before attaching too much significance to it. In this case the 40 week (200 day) moving average sits not far above the neck line, at around $1252. If the current rally is going to be just another minor correction, we may well see gold struggle to get clear of the neckline resistance and 40 week moving average. However, if things go the other way, a clear break above this level would be a positive sign for technical traders, suggesting more gains to come.

Ric Spooner is chief market analyst at CMC Markets. @ricspooner_CMC

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