Gold spikes higher: Dead cat bounce, or more upside in store?

Gold prices are practically flat in 2018, as concerns around geopolitics and trade that would typically boost demand for the precious metal have been counterbalanced by a resurgent US dollar. While more dollar strength may keep gold under some pressure in the near-term, it would not be surprising to see the metal come back in fashion later on, in case geopolitical tensions or the “trade war” escalate.

Price action in gold has been a tale of two narratives this year. On the one hand, the increasingly uncertain geopolitical landscape and anxieties around global trade are boosting demand for the precious metal, which is considered a safe-haven asset. This was evident once again on Thursday, when prices spiked higher following headlines that the peace summit between the US and North Korea had been cancelled, which was seen as increasing the probability of a re-escalation in tensions on the Korean Peninsula.

On the other hand, a resurgent US dollar and rising US Treasury yields are exerting downward pressure on prices. Since gold is priced in dollars, an appreciating US currency makes it more expensive for investors using foreign currencies to buy the metal, diminishing some of its demand. Moreover, rising yields are also seen as a negative development for the yellow metal, which not only doesn’t bear any yield to hold but also carries storage costs.

The key question for gold prices moving forward is which one of these forces will dominate, or eclipse, the other. In other words, will a strengthening dollar overshadow uncertainties emanating from the geopolitical and trade spectrums and push gold lower, or will an escalation of tensions on those fronts eclipse considerations around the dollar and lead to gains in gold?

Looking at the dollar first, besides rising US yields, it has also strengthened due to other major currencies like the euro underperforming, amid a slowdown in Eurozone’s economy generating jitters the ECB will be hesitant to scale back its massive stimulus program, as well as political risks in Italy. Meanwhile, the US economy is stable, and the risks surrounding Fed rate increases this year are skewed towards more hikes than currently priced in. These suggest the latest recovery in the dollar may well continue for a while yet.

On the trade front, although the situation appeared to be calming down lately, a recent announcement by the US that it is considering imposing tariffs on imported cars “ruined the party”. If officially announced, such tariffs would likely lead to another wave of risk aversion amid speculation for a tit-for-tat retaliation by the EU and Japan, who are the main exporters of automobiles to the US. That said though, any such announcement may still be a few weeks away. The US Commerce Department launched an investigation into the matter, and any tariffs will have to be based on the results of that study, which is still pending.

As for the geopolitical front, the outlook is highly uncertain. Peace talks between the US and North Korea appear to have been delayed, but not derailed, as North Korea continues to express willingness for negotiations. As such, the scenario of a return to aggressive missile tests appears unlikely, for now at least. Elsewhere, the situation in the Middle East and particularly between Israel and Iran bears close monitoring. Tensions between the two have heightened recently, and any further escalation could be a supportive factor for safe havens like gold.

Overall, a reasonable scenario for gold prices is one where the precious metal corrects a little lower over the coming weeks as the US dollar gains some more ground, only to spike back up on a potential tariff announcement by the US, as the “trade war” theme comes back to the forefront.

Technically, gold prices are trading just below their 200-day moving average (MA) and it will be crucial to see whether they can break back above it, or whether it will act as a resistance barrier and cap further advances. If the bulls break above it, that could signal the outlook is back to neutral and set the stage for advances. A potential break back above the 200-day MA at $1307 could open the way for the $1326 barrier, marked by the highs of May 11. Further bullish extensions could aim initially for the $1341 zone, and subsequently for the $1355 area, defined by the peaks on March 7 and April 19 respectively.

On the other hand, a failure to move back above the 200-day MA would keep the technical outlook cautiously negative, increasing the likelihood for pullbacks. Declines in prices could encounter immediate support around the $1301 territory, which also encapsulates the $1300 psychological area. A downside break of that level may pave the way for a drop towards the May 21 low of $1282, with even steeper declines bringing into focus the November 3 low of $1265.