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    Gold: will it shine or crumble at $1220?

    Yesterday saw precious metals stage a strong rally as both the dollar and equities sold off.  The dollar extended its recent bad run of form on the back of further weakness in US data, which basically pushed the Fed rate hike expectations further out. This time it was retail sales that delivered the knockout blow to the US currency as it showed no change month-over-month in April when a small rise was expected. In fact, this gauge of consumer activity has failed to meet the consensus on 10 out of the last 13 months, which speaks volumes about the health of the world’s largest economy.  The dollar has also lost its appeal because of a rebounding euro and the British pound, with the latter surging higher in part because of the surprise outcome of the UK election last week. The on-going uncertainty about the future of Greece, among other things, continues to weigh on the European stock markets, further boosting the appeal of gold.  For all these reasons, gold and silver have found solid support this week and both metals are pushing higher as I go to press.

    Although no one seems to be too sure why the benchmark government bond yields have risen sharply recently, this could actually be good news for gold in the short term as investors price out the possibility of the global economy falling into deflation. That’s because historically, inflation – or at least the market’s expectation of inflation – and yields tend to go in the same direction. If Mr Market thinks that higher inflation may be on the horizon, yields will typically rise in order to compensate for the loss of the purchasing power of future cash flows of bonds. Therefore, if it is indeed inflation that the market is worried about – or happy that deflation is not forthcoming – then inflation-hedging assets like gold should benefit as a result. Is this what we are witnessing now? But much higher yields will not be good for gold either as yield-seeking investors would rather hold bonds than gold, which apart from potential capital appreciation, would not pay anything else and cost money to store. Nevertheless, gold could find further buying interest in the short term if this view turns out to be correct.

    Another reason why I think gold has a high chance of extending its gains is the current negative sentiment on the metal. Typically, the markets turn when sentiment is at an extreme – think of the stock market rally that began in March 2009, for example, or indeed the precious metals’ slump in 2011. At the moment with global inflation being this low and US equity markets near record highs, not many people are giving the shiny metals much attention. Indeed, the latest demand trends report from the World Gold Council (WGC) underscores this view. According the WGC, total demand for gold was down 1% in the first quarter versus the same period a year earlier. Jewellery demand was particularly weak in China, the world’s top gold consumer, down 10%. Nevertheless, this was offset by a sharp rise in Jewellery purchases of the former top gold consumer nation, India. What’s more, investment demand showed a modest recovery as ETF inflows rose 4% over the quarter. On top of this, central bank purchases expanded for the seventeenth time last quarter, although it was little-changed from the first quarter of 2014.    

    So, in the near-term, the stage looks set for gold to extend its rally further. But it is questionable at the stage whether a major, sustainable, rally could be on the way or indeed if a bottom has already been established. Nevertheless, gold’s long-term charts are showing positive technical signals.  

    Usually prices move before the wider market becomes aware of any changes in the fundamental outlook of an asset. For this reason, we should approach gold and any other market with an open mind and interpret the technical signals objectively rather than emotionally. Indeed, gold has certainly formed a few bullish signals on its weekly chart, not least the bear’s inability to break decisively below the long-term 61.8% Fibonacci retracement at $1155 on at least five attempts since November. Anyone who trades gold will know how important this 61.8% Fibonacci retracement level is on literally any time frame.  So the fact that the long-term 61.8% level is holding, this is very encouraging for the gold bugs indeed.  What’s more, gold has created a couple of higher lows already and is on the verge of making another one if it breaks decisively above the $1220 horizontal resistance level and the 200-day moving average at $1218, both of which are being tested as I go to press. If broken, the next logical target – you guessed it – is the 61.8% Fibonacci retracement of the downswing from the January high at just shy of $1245. Beyond the 61.8% Fibonacci level is the long-term downward-sloping trend of the falling wedge pattern around $1270. If and when gold breaks this barrier then we could be talking about much, much, higher levels. Meanwhile, if the sellers defend this $1218/20 area then we wouldn’t be surprised if gold drops back to support levels at $1200 or even $1180, before deciding on its next move. Put another way, gold is currently at a key technical juncture and what it does next could determine the near-term direction at the very least. More importantly, gold’s next move could certainly open some decent trading opportunities.

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