Gold And The Interest Rate Conundrum

Gold market participants are well aware of the outsized role of the U.S. dollar on the metal’s price trend. Less widely known is the impact which interest rates play in determining gold’s near-term direction. In this report, we’ll examine the sensitivity gold has shown of late to fluctuations in real interest rates. I’ll also make the case that a pullback in U.S. Treasury bond yields in the coming days would also give gold a needed boost and allow the bulls to regain full control of the metal’s immediate-term trend.

After the selling pressure in the first half of September, gold prices are trying to stabilize as we head toward the end of summer. While the metal recently had its first true “dip” in several months, it’s still within reach of a multi-year high and is also still above its widely watched 50-day moving average (below). However, gold has lost some of its safe-haven appeal lately and as such remains vulnerable to additional weakness in the immediate term. As long as the U.S.-China trade war remains on the backburner, the temptation will be high for traders to rotate out of precious metals and into equities.

Gold Continuous Contract

Source: BigCharts

Another factor which has heavily influenced gold’s performance in recent weeks is the sharp reversal in real interest rates. The gold price tends to move inversely to the yields on inflation-protected Treasury securities or TIPs. Shown here is the performance of the 5-year TIPs yield in just the last two weeks. The rally in the TIPs yield coincided with the gold price pullback as investors fled the safety of the bond market, temporarily driving yields higher. Higher yields also make non-yielding bullion less attractive to investors.

Source: Treasury Department

An important factor which would help repair gold’s immediate-term (1-4 week) trend would be for Treasury yields to pull back in the wake of the Federal Reserve’s 2-day policy meeting this week. The Fed is widely expected to cut its benchmark interest rate by at least 25 basis points. A cut in the Fed funds rate would be a short-term positive for gold and would likely encourage at least a partial reversal of the recent Treasury yield spike.

The 10-Year Treasury Note Yield Index (TNX) shown below is just barely above its 50-day moving average as of Sept. 17. You can see here that TNX spent the better part of the last few months under this psychologically significant trend line. Gold’s best chance for a rally will occur if TNX slips under the 50-day MA in the coming days, which would indicate that rate-related pressure against the metal is waning.

CBOE 10-Year Treasury Note Yield Index

Source: BigCharts

Another near-term support for gold would be for the U.S. dollar index to break decisively below its 50-day moving average. One of the best months for gold this year was when the dollar broke under the psychologically significant 50-day MA in June. This can be seen in the graph of the Invesco DB U.S. Dollar Index Bullish Fund (UUP), my favorite dollar proxy.

Invesco DB U.S. Dollar Index Bullish Fund

Source: BigCharts

The dollar’s relentless strength since July, however, has served as a headwind for the gold price. Gold investors were content to ignore the strong dollar during the trade war panic in August, but now that both the rhetoric between the U.S. and China is less bellicose, participants can no longer ignore gold’s currency component. Any additional strength in the dollar from here would, therefore, likely further weaken gold’s near-term outlook. My expectation, however, is for the dollar to weaken heading into the fourth quarter of this year. That would provide gold the necessary basis for a return to strength despite the loss of safe-haven demand stemming from trade war fears.

Turning our attention to the gold mining stocks, the benchmark PHLX Gold/Silver Index (XAU) still hasn’t confirmed an immediate-term bottom yet. As previously mentioned, a 2-day higher close above the 15-day moving average is needed for my trading system to confirm a bottom. As of Sept. 17, the XAU hasn’t yet managed to close back above the 15-day MA. This underscores the unsettled nature of the actively traded mining shares following the XAU decline earlier this month.

PHLX Gold/Silver Index

Source: BigCharts

Providing further insight into the gold stocks as a group, the 4-week rate of change in the number of U.S.-listed gold shares making new 52-week highs minus lows is still in decline. This indicator is an important measure of the incremental demand for gold stocks. It shows the near-term path of least resistance for the mining shares as a group; as such, we need to see a reversal in this indicator to accompany the next confirmed bottom in the XAU index. As you can see here, the momentum in the new highs and lows is trying to bottom but hasn’t reversed yet. For now, a cautious approach to gold stocks is advised with no new trading positions recommended.

Source: NYSE

Although gold and the mining shares remain unsettled on an immediate-term basis, there are indications that the coming weeks will see a revival in interest in the precious metals sector. A decline in the U.S. dollar index, along with a pullback in Treasury yields, would pave the way for a short-term gold price recovery from a fundamental standpoint. From a technical perspective, a reversal of the downward momentum of the net new highs in the actively traded mining shares would also set the stage for a gold and gold stock short-covering rally as we are heading closer to Q4. And while gold’s immediate-term trend is still weak, its longer-term trend is still bullish and investors can maintain longer-term investment positions in the yellow metal.

On a strategic note, I was stopped out of my trading position in the VanEck Vectors Gold Miners ETF (GDX) after it violated $28.00 level on Sept. 9. A 3-month rally in GDX and a gain of almost 30% made this a worthwhile trade. The recent pullback in GDX, however, puts me back in a cash position on a short-term basis as I await the next confirmed bottom and re-entry signal from my technical trading discipline.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


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