Gold revival still depends on the dollar

Ole Hansen

Head of Commodity Strategy

Gold is trading back above $1,200/oz as it continues to recover from its mid-August nadir. A continued recovery could eventually trigger an accelerated rally due to short-covering from hedge funds currently holding a record short. For now, the key source of inspiration for gold traders remains USD, and this is true for both bulls and bears. 

The strong dollar surge following the collapse of the Turkish lira was halted in mid-August when President Trump criticised the Federal Reserve while saying that Jerome Powell had not been the cheap money chairman he had hoped for, and as a result the dollar was too strong. 

(Some other reasons for the latest dollar weakness and renewed appetite for risk can be found here in John Hardy’s latest forex update.
 
Gold is currently challenging the next area of resistance at $1,217/oz with a break above opening up for a move to $1,235/oz. Continued dollar weakness is needed to trigger a short-covering rally from funds holding a record short.

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Source: Saxo Bank
Since then the greenback has continued to lose ground despite firm signals, as per the recent Federal Open market Committee minutes and last Friday's Jackson Hole speech by Powell suggesting the Fed is readying more rate hikes. One of the best performing major currencies has been the euro (+3.5% from its mid-August low) which despite worries about Italy has been supported by macroeconomic data that continue to beat estimates. 

The Citi Economic surprise index, which measures economic data surprises relative to market expectations, shows the current divergence between the Eurozone and the US where data have warned about a dollar turnaround for some time now, with data weakening relative to expectations.
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The Chinese yuan maintains a very high historical correlation to gold and the two have continued to recover after the People's Bank of China sent a signal (through the use of various measures) in mid-August that a USDCNY rate above 7 was unlikely to be tolerated. Since then, the yuan has advanced by 1.9% while gold has added 3.4%.
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The market will now increasingly be looking for signs of if and when hedge funds begin to abandon their record net-short position in COMEX gold futures. During a six-week period up until August 21, they accumulated a record short of 79,000 lots, some 3.3 times bigger than the previous record from December 2015. 
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A recovery in gold may attract an even bigger interest in silver given its relative cheapness. The XAUXAG ratio currently trades at 81 (ounces of silver to buy one ounce of gold); silver has only traded above this level on a few occasions over the past 10 years.
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