Several core events last week caused gold to trend down and not eclipse its previous peak.
The Comey hearing took a lot of risk off the top of markets, providing direct strength to the dollar.
The UK elections and the recent ECB meeting both caused weakness in the FX markets, also lending strength to the dollar.
A downtrend is imminent for gold and investors should bump up allocations to risk-off assets.
Gold had quite the interesting week after seeing three major events. First, there was the Comey hearing, where there was found to be no significant evidence against the President, at least none that could lead to an obstruction of justice charge. Then, there was the UK election, for which the Conservative party lost the majority, as the Labour party performed better than expected; yet, gold lost strength. The ECB meeting didn't support the euro and that led to dollar strength and subsequently outflows in gold. In the week ahead, I think investors need to substantially reduce their gold hedge in the SPDR Gold ETF (NYSEARCA:GLD), if not entirely, as the dollar may pick up steam, especially at the June FOMC begins.
Despite Global Risk, Markets Continue Higher
This past week saw quite a few major events impact global markets. Beginning with the Comey hearing, markets initially rallied as there was no substantial evidence against the President versus what had been anticipated a few weeks back with the "Comey memo." This takes a lot of pressure off of equity markets, as the negative outcome of this hearing could've created a large amount of political instability and it could've sent the dollar into a tailspin. With this out of the way, a large risk has subsided and investors can focus their attention on central bank meetings.
We also saw the dollar's momentum tick up above 40 for really the first time since the beginning of May, potentially signaling a larger uptrend is on the way. However, a similar pattern to what we are seeing right now in the dollar was seen just prior to the last decrease in early May, so, on a technical basis, I wouldn't be surprised if the dollar went lower. In the week ahead, the closer the dollar can get to its 50 DMA will be viewed as progress and I think this directly leads to outflows in gold. I expect momentum in the dollar to pick up and perhaps by the end of the month, we could be looking at a significantly stronger dollar than the current level of 97.24.
On a fundamental basis, this past week showed us that the current Administration can get reform underway. The Financial Choice Act, as it is dubbed, passed in the House of Representatives and is a monumental first step towards unwinding restrictive parts of Dodd-Frank. This provided validation to the market that the current Administration can deliver on campaign promises and, not only did this send the financial sector higher this week, but provided a basis such that the dollar can reverse its current downtrend and head higher over the coming months. The pessimism towards tax reform that has been present in recent weeks may now shift towards optimism and there is a clear precedent.
As for the UK elections, it goes to show just how important intramarket relationships are. As the conservative party, led by Theresa May, lost the majority, despite still winning the election, the pound began to rapidly depreciate, as seen below. This helped the dollar to rally and subsequently the price of gold to fall. The interconnectivity of the market is clearly displayed, here. The more important theme here is that G7 FX counterparts have been rallying against the dollar in 2017 and now that theme may begin to unwind. The outcome of the UK election was unexpected and that may result in a new downtrend for the pound relative to the dollar. That provides short-term support for the dollar and short-term weakness for gold.
Of course, rewinding and looking at the impact of the ECB meeting, the euro also depreciated relative to the dollar. No change was made to the current quantitative easing policy, where the ECB is buying 60 billion EUR of bonds every month; however, Mario Draghi made clear that at some point, based upon the growth in inflation in Europe that tapering will be necessary. Yet, Draghi declined to give specifics as to when QE will end and the market was clearly looking for a more definitive statement. Now, the euro finished the week lower, helping to drive further support for the dollar against gold. I expect the euro to trade down in the weeks ahead, but there's core support at $1.10.
Looking forward to this week, I believe the only major event that'll move gold markets is the June FOMC meeting. At this point, a second rate hike for 2017 is priced in, with the current probability of the hike being 99.6% according to the CME Group. The ECB and outcome of the UK election have set their respective currencies in motion to the downside to provide passive support to the dollar over the coming weeks. Investors should be keen on watching what Fed Chairwoman Janet Yellen says about the reduction process and timeline for the Fed's balance sheet. Additionally, investors should focus on how relatively hawkish her tone is with respect to a third interest rate hike this year. Pushing that third rate hike to Q1 2018 would send a dovish signal to markets, driving up the price of gold. However, I think the risk here is to the downside of gold as I believe her tone will be moderately hawkish.
How Will GLD Perform?
I thought the events that were on the table last week - the Comey hearing, the UK election, and the ECB meeting - would be enough to send gold past $1,300/oz; however, it seems as though the market had been discounting these events prior to the last week, creating risks skewed to the downside. As gold now approaches its 50 DMA at $1,250/oz, downside risk is now at $1,220/oz. While I'd be surprised if it fell below that level in the next couple of weeks, it's entirely possible depending on what happens with the June FOMC and Yellen's outlook for future rate hikes as well as a reduction of the balance sheet. Gold was nearly overbought, too, at its peak this past week. Investors should be taking this one day at a time and carefully monitoring the risks associated with each major fundamental event.
For GLD, the fact that we didn't breach resistance at $123 is important and means that there's potentially more downside ahead. Again, like gold itself, it'll be interesting to see where this ETF trends over the next couple of weeks. If it falls through the floor of $116, I think we have a larger problem on our hands. Investors that are still keen on hedging the current market can do so, but I would advise not with gold. If the gold hedge is retained, investors will watch as unrealized losses build over the next couple of weeks, undercutting the strength of a heavily weighted equity portfolio. I think investors need to be out of GLD at this time.
Last week was quite the eventful week for markets, with many global events playing out unexpectedly. The Comey hearing showed no signs that could point to the President obstructing justice, the UK election resulted in the Conservatives losing the majority, and the ECB refrained from providing markets with any real timeline for QE tapering. In the week ahead, the June FOMC could prove to be a large positive for the dollar and investors should not be long gold. The failure of gold to breach $1,300/oz and GLD to take out $123 may mean that a new downtrend is on the way.
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