Gold prices have seen a sharp rise over the past several weeks. The precious metal has been marking new highs ever since it broke above the $1,750 mark. Over the past month, the yellow metal has gained over $121, or 6.80 per cent, till of July 24.
Technical charts show the monthly bar is yet to be completed, but there may not be any significant change in these figures and the yellow metal is on its way to post one of its best monthly gains in the recent past.
So, is the current rally in gold price a direct threat to equities? The answer is no. It may be an early sign of cooling off of the equity market, but poses no direct threat in the immediate short term.
Equity as an asset class is on its way to see a stable rotation against other asset classes. The equity market may take a breather, or consolidate. But this would be governed by its own technical factors, and not by the rally in gold, even if though the asset class enjoys a negative correlation with equities most of the time.
The gold rally can directly be attributed to weakness in the US dollar. A couple of charts can explain this best.
ET CONTRIBUTORSThe daily chart of the Dollar Index (DXY) needs no explanation. It is evidently weak with every possible zone taken out on the downside. More insights can be derived from the weekly chart below.
ET CONTRIBUTORSThe weekly chart above shows that after a sharp rally in 2014-2015, which took Dollar Index from 76 to 100, it has been in a massive sideways move over the past five years. It suffered two failed breakout and two failed breakdowns with neither of them triggering in any change of trend. In a large-ranged movement, we also see a mildly upward rising channel is breaking down in between. During these times, the RSI continuously had a bearish divergence while making lower tops.
If the current trajectory continues, the DXY can easily test the 93.50 – 93 range in the near term even if it stabilises in the immediate short term.
The weakness of the Dollar Index is also visible in the way other currencies are behaving against the greenback. This is reflected in the Forex Relative Rotation Graph below.
ET CONTRIBUTORSIn the above Relative Rotation Graph (RRG), all major currencies like the Australian dollar, Indonesian rupiah, New Zealand dollar, Canadian dollar, Singapore dollar, British pound, Indian rupee and Chinese yuan are rotating positively and outperforming the dollar on a relative basis.
Only the Japanese yen does not seem to be favourably placed against the dollar. All these currencies are benchmarked against the greenback.
This relative rotation chart might be showing some early signs of the equity market cooling down, but still continuing to relatively outperform other asset classes.
The ‘risk on’ environment that started exactly eight weeks ago, continues to be comfortably placed at this point in time. Equity as an asset class is represented by ITOT (iShares Core S&P US Stock Market ETF). It is currently on the verge of entering the leading quadrant, though it mildly appears to be tapering off in terms of relative momentum. But that does not show any immediate sign of a worry. Followed by that is commodities, represented by DJP (iPath Bloomberg Commodity Index Total Return ETN).
We will have a reason to worry only if asset classes like bonds and gold start moving towards the improving quadrant. It appears they have a large distance to cover at this point in time. All these assets are benchmarked against VBINX – Vanguard Balanced Index Fund.
At this point, the Indian equity markets looms better placed. When compared with the MSCI World Index, the broader Nifty500 Index is placed in the improving quadrant and it may relatively outperform other Asian peers like the Hang Seng, Straits Singapore, Shanghai Composite and even S&P500 Index on a relative basis.
(Milan Vaishnav, CMT, MSTA, is a Consulting Technical Analyst and founder of Gemstone Equity Research & Advisory Services, Vadodara. He can be reached at milan.vaishnav@equityresearch.asia)