As the stock market enters the late stages of its bull run (see my last post Market top ahead? My inner investor turns cautious), inflation hedge vehicles typically rally as inflationary pressures rise. We are starting to see a similar effect in gold prices.
As the chart below shows, the recent weakness in gold prices can largely be attributed to USD strength (green line, inverted). One constructive element for the gold price outlook is the positive RSI divergence as the price tests support.
Sentiment also appears to be washed out. The latest update of CoT data from Hedgopia shows that the positions of large speculators, or hedge funds, in gold futures are at or near capitulation levels.
Inflation expectations rising
Moreover, gold prices have been lagging as inflation expectations have risen. Even as gold violated an uptrend line, inflation expectations in the credit markets have been steadily rising.
Another factor supportive of gold is seasonality. If history is any guide, August and September tends to see an above average probability of higher gold prices.
The key risk to the bullish gold thesis is the US Dollar. The USD Index is testing a key resistance level while exhibiting a negative divergence, which should see the greenback retreat and commodity prices rise. However, there are no guarantees when it comes to market behavior. If the USD Index does stage a decisive upside breakout through resistance, all bets are all.
As an aside, the fate of gold prices, and the USD Index has broad implications for Sino-American trade tensions. With the caveat that correlation does not represent causation, Market Commentary observed that Chinese yuan (CNY) to gold stock (XAU) volatility has been falling, which suggests that the Chinese may be pegging their currency to gold.
The volatility of CNY to broad commodity prices tells a similar story.
Should the USD retreat, and gold prices fall, CNYUSD is likely to rise, which would alleviate market concerns about a trade war turning into a currency war. Such a development would act to reduce risk premiums, and be bullish for stock prices.