Gold can help you with a good night's sleep. But what about returns?

gold is often considered a haven is because we all have seen stock prices crashing, but the same can’t be true for gold. There is no counterparty or credit risk.

If we talk in today’s context, unlike a bank, gold cannot go bankrupt! This also reminds me of a dialogue from a popular web series “Scam” where the protagonist’s father in a financial crisis goes to a moneylender and pledges his gold in return for cash. He says, “Ghar main agar sona ho, toh aadmi chain se soo sakta hai“. Meaning if there’s gold in the house, one can sleep peacefully even amidst any financial crisis.

Such is the faith people have in this commodity. Back to our point, the combination of all the above factors mentioned has been responsible for strong outperformance in gold recently. Let’s understand the events that have panned out in the recent past, and we will have an idea of the reason behind a strong rally in gold prices:

1) Worsening banking credit crisis in US & Europe – In times of uncertainty, demand for gold increases as investors flock toward safe haven assets

2) Concerning data points in the US with respect to consumer confidence, Unemployment & Inflation – The GDP, unemployment & consumer confidence index numbers have been largely negative, increasing the fears of recession. The news of major FANG companies announcing huge layoffs further dented the sentiments.

3) Central Banks around the World buying Gold in record quantities – Central Banks around the world kept on increasing the stockpile of gold. This includes the Bank of China, the Bank of Russia, the Central Bank of India, Turley, Egypt & Qatar.

4) Weakening of the Dollar Index in the last 1 year –With a slump in economic activity, the dollar Index came down from 115 levels to 100, making it cheaper & directly increasing demand for Gold.What has Gold been doing?
Of late, the yellow metal is very much in the limelight. After all, this commodity has rallied from almost 47000 odd levels to 60500 levels in the last 12 months. That’s a rise of almost 25%! On NYMEX prices broke the 2000$ mark for the first time since early 2022.

Exhibit 1 – Gold price rally
Historically the precious metals tend to remain sideways/bearish for prolonged periods when the economy is not doing well.

For example, if unemployment numbers are lower than expected, GDP is growing, inflation is moving southwards, and Consumers have more money in their hands to spend, gold as an asset class will typically underperform. On the other hand, if the economy is in the doldrums, there is a situation of uncertainty all around, job losses, a high inflationary scenario, and lower spending power, gold mostly tends to outperform. The below chart highlights the last 10 years of the relationship between Gold &Y Equity markets (DJIA index). It clearly shows the inverse relationship between Gold prices & the equity markets.

The blue line is the DJIA index representing the top companies by market cap in the US, and the orange line is Gold prices. You can observe, whenever the DJIA index has moved up & staged a rally, gold has either moved sideways or come down sharply. Well, the question is why does this happen?

WHERE DOES GOLD GO FROM HERE?
The obvious question everyone would have is where does the yellow metal go from here? We will have a both fundamental & Technical approach in drawing some conclusions –

Fundamentally, all eyes would be on what Fed does next. Historically there has been a negative relationship between Gold & Interest rates. If the Fed decides to pause on rate hikes, & signals a more dovish stance Gold prices may continue to rally for some more time. For starters, when the interest rates fall people don’t get good returns on their deposits, causing an increase in Gold demand & and its price. On the other hand, if the Fed continues its rate hike trajectory, Gold may see some correction in the medium term.

If we look at energy prices, members of OPEC in early April announced surprising cuts to their production targets. Higher energy prices tend to be inflationary in the shorter term. So fundamentally there are a lot of moving variables that one has to keep a watch on in order to forecast Gold prices. Consensus opinion, however, remains that Fed will move towards a more dovish stance as far as interest rates are concerned & sentimentally this might be a little positive for Gold & most of it is already factored in, in the recent Gold price rally.

Technically, as can be seen on the chart, Gold is near a “Make or Break area”. Meaning it is at the cusp of a breakout. Gold is fiddling near all-time high levels of 2089-2090, & any positive news would trigger a breakout. However, this is exactly the time to hold on to one’s nerves. The rally in Gold prices has brought it to a resistance point, from where prices have retraced on multiple occasions. Any negative candlestick confirmations in this area are likely to have a short-term negative impact on Gold prices. In other words, purely from a reward-to-risk perspective, THIS IS NOT A TIME TO BE A BULL ON GOLD. While intraday spikes could be observed, fresh buying at these levels has the risk of trapping investors near all-time high levels.

A better plan would be to wait for a decisive breakout and take a trade in the direction of that breakout. We will be all eyes & ears on what’s happening in this space & would be quick as usual in coming up with a fresh update.

(Rahul Ghose is Founder & CEO at Hedged)

This article was originally published by Indiatimes.com. Read the original article here.