What really drives the Gold Price
There continue to be all sorts of purported analysts out there who insist that the price of gold is determined through physical supply and demand. These folks cling to the arcane notion that somehow fundamental factors are the key determinant of the daily price.
Nothing could be further from the truth.
Whether it’s organizations like the World Gold Council, sell-side bullion bank scribes or internet prognosticators, the vast majority of these “analysts” believe that the primary driver of the gold price is physical supply and demand. They cite global mine supply, GLD flows and sovereign demand as their primary sources for this analysis.
But since 2014, we’ve argued that the primary driver of price on a daily basis is instead the HFT reaction to changes in the single forex pair USDJPY. Below is one of the original charts we posted back in November of 2014. Note that prior to The Great Financial Crisis of 2008, there was no clear correlation between the yen and gold. However, since then, and with the now-present central bank management of nearly every “market”, the correlation is obvious.
If we bring this chart up-to-date and look at just the past four years, we see the result below. Note that the inverse of the USDJPY is in candlesticks, and the continuous COMEX gold contract is displayed as a blue line.
Upon closer inspection, however, it appears that a major shift has occurred in 2018. Since late January, there has been a significant divergence in the yen-gold correlation. While the yen has steadily appreciated against the dollar, the price of COMEX gold has been flat and has not kept up. See below:
And it is as if the Bank and/or Spec HFT computers have been reprogrammed. Where the yen-gold correlation had been tight on a nearly tick-for-tick basis, the price of COMEX gold now closely correlates with the dollar index, or perhaps more specifically the euro, instead. The chart below shows the euro in candlesticks and the continuous COMEX gold contract as a blue line.
IF a change has truly taken place, and IF the dominant algos have now pegged the price of COMEX gold to the dollar index or euro, then the single most important driver of the COMEX gold price in 2018 will not be mine supply, sovereign demand or ETF flows.
Instead, the single most important factor will be the general trend in the dollar. If the dollar recovers and rallies, the HFTs will sell COMEX gold exposure and price will fall. If the dollar continues to slide, the HFTs will continue to seek COMEX gold exposure and price will rally.
Back in early January, we laid out our thesis for dollar weakness in 2018, and we urge you to read it now if you missed it back then: https://www.sprottmoney.com/Blog/the-three-major-t…
In the end, it is vitally important that you understand that “the markets” in 2018 are not the same as they were in 2008 or 1998. Instead, “markets” are primarily controlled by High Frequency Trading computers whose algorithmically-based programs swap positions at the speed of light.
As this pertains to the precious metals, it’s clear that fundamental factors such as physical supply and demand have little to no impact on price. Only a recognition of this basic fact gives you an understanding of what drives price on a daily or weekly basis. – Craig Hemke
With US Dollar In “Crisis Zone,” Gold Investors To Profit
Gold is likely to be bolstered by a falling US dollar, which is under pressure despite rising bond yields, according to a U.K.-based research firm.
Gold rallied Monday in part because of a weakened US dollar. June gold futures settled the day at $1,346.9, up 1.5% on the day.
In a recent report, analysts at CrossBorder Capital said that a growing U.S. government deficit is likely to require funding by additional Treasury new issuance, driving bond yields higher. But counter intuitively, they expect that this will weigh on the U.S. dollar.
“[New bond issuances] can only add further upward pressure on yields across the U.S. curve. It is not U.S. dollar bullish because foreign demand for U.S. ‘safe’ assets is falling,” the report said.
While rising interest rates are typically bullish for the dollar, the report said that the world’s largest reserve currency is in a precarious position that makes it immune to rising rates, in what CrossBorder Capital calls the “Crisis Zone.”
The report likens the dollar’s current behavior to the “Carter Dollar” of the late-1970s during which “despite interest rate differentials widening in its favor, the USD exchange rate continued to slump.”
Analysts noted that the US dollar’s deviation from historically positive correlations with rising rates can be attributed to a rising term premia, which suggest that U.S. safe-haven assets are less attractive.
“Term premia are a crucial factor in all asset valuation. They represent the excess yields required by investors to hold Treasuries above the expected value imputed from future policy interest rates,” the report said.
According to the research firm, term premia tend to be high when there is an excess supply of Treasuries, thus, President Donald Trump’s budget deficit would see government bond issuance drive term premia up.
Additionally, the report noted that money that has been heavily invested into U.S. safe-haven assets between the years 2012-2016 is now leaving the U.S. in favor of economic acceleration in Europe and Asia. A diminishing overseas appetite for U.S. safe-haven assets means more headwinds for the dollar as capital leaves the world’s largest economy. – David Lin
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