Over the last year, dollar was doing very well, which limited increases in gold prices. However, temporary weakness of the American currency was enough for that metal to immediately rise to its 6-year high.
As a reminder: after soaring to all time high in 2011, gold cost 1950 USD. In the following years metal was becoming cheaper and reached its low at the turn of 2015 and 2016. At that time, price of one ounce of gold was 1050 USD. Since then, yellow metal started to getting more expensive, but over the next 3 years was not able to break 1360-1380 USD level.
source: Sourav Saha
Few days ago this barrier was finally breached. This is important because some investors or speculators take the given asset into consideration only when it break the so-called resistance level. In case of gold, this was aforementioned 1360-1380 USD.
Involvement of additional market players has triggered gold to continue its rally, even reaching 1440 USD for a moment. Eventually, the closing price was about 1420 USD. Anyway, we're talking about an increase of almost 12% in just over a month! In case of gold, it's a really huge move.
Over the last 2-3 days gold price has been catching its breath and has fallen a little, which does not change the fact that it is at its highest price from 6 years.
Paper price of gold
Before we consider gold prospects for the following weeks, a small explanation for those who have not read Trader21 older articles. It explains how to set the dollar price of gold, which we see on all investment portals on daily basis.
Gold price is largely dependent on what happens on the stock exchange (so-called Comex). Gold trading at Comex has very little to do with real metal exchanges between stakeholders. It comes mainly to trading certificates that imitate gold. As a result, at Comex there are contracts trading worth tens of millions of ounces of gold, and in fact in Comex stores (as collateral) there are only several million ounces, of which only a small part can actually be delivered. The rest is the metal which belongs to banks and could not be used for settlement.
One will ask: what's the difference? Actually, it is significant. Suppose that trading is based on physical metal. A buyer appears and must raise the price until someone is found who is willing to sell the good. Meanwhile, in the current reality, when a buyer appears on the stock exchange, banks simply create a certificate which supposed to be the counterpart of gold. In this way, demand is satisfied.
1. At the moment, the total number of open gold contracts is 570,000. Each contract is 100 ounces, so contracts are an equivalent of 57 million ounces.
2. The total amount of gold stored in Comex stores is 7.6 million ounces, the majority of which is owned by someone (it can not be used to settle contracts).
3. Gold that actually can be used to settle transactions is just 320,000 ounces.
In other words: for every real gold ounce, there are 178 ounces in form of paper certificates.
What's next with the gold price?
Gold is called the "anti-dollar" for a reason. The price of bullion grows when uncertainty about the condition of the global economy or stability of the entire system increases (which dollar is a key part of).
Increase in the price of gold is not desired by the greatest beneficiaries of the current system. Therefore, it can be expected that the last metal rally will not remain without a response.
Analyst David Brady estimated that at the moment banks are betting on gold declines on a similar scale to that of mid-2016. What did happen then? Gold finished its half-year rally and recorded significant drops (from 1370 USD to 1140 USD).
Even more precise is Dave Kranzler, who drew attention to the way in which a growing number of contracts for gold (meaning increased banks activity) affects metal quotes. Kranzler noticed that when on Wednesday 19th June gold started to move up during the Fed conference, number of contracts fluctuated around 520 thousands. Only two days later, the number of contracts increased to 572 thousands. In this way, we have reached levels at which the gold price has been trying to break for the last 3 years.
- in July 2016, the number of open contracts exceeded 600 thousands. Then the price fell by over 15%.
- in September 2017, the number of open contracts exceeded 580 thousands. Then the price dropped by 8%.
- in January 2018 the number of contracts again exceeded 580 thousands. In the following months, price fell by 14%.
Based on the above data, Kranzler believes that strong attack on the price of gold can be expected in the next 10 days. At that time, there is a holiday in the US (July 4). Fridays and holidays are the times when volume is falling - for banks it is the best moment to attack gold.
We agree with Kranzler that in the following days gold will be under significant pressure. Drops are very likely. On the other hand, we believe that the six-month declines not gonna happen, as we explained at the examples mentioned above.
Because today the situation looks radically different than in 2016 or 2017. At that time, central banks have been printing money, and buying shares or bonds. Tightening monetary policy was under preparation. In the U.S., however, interest rates were raised, which led to weakening gold prices.
In 2019, it turned out that due to enormous indebtedness and weakening economic situation, all major central banks had to loose policy again. This means, among other actions, interest rate cuts, in some cases below zero. Thus, real interest rates (accounted for inflation) will be strongly negative. Historically, in such situations, gold has always performed very well.
On the graphics, periods of negative real interest rates are in gray areas. See how the gold price (gold color) behaved during these times.
Of course, we do not know yet what the scale of interest rate reductions will be. At the moment in the U.S., two rate cuts (each by 0.25%) are expected in the next quarter (July and September).
In line with our expectations, central banks' narrative change triggered an immediate increase in gold prices. So far, we are after strong rally (12% in a month). Thus, right now common sense suggests caution. There are many indications that attempts will be made to reduce the price of gold. In our opinion, it is most likely that it will go down to 1380 USD and from that point will start to increase.
How strong the increase will be? It depends on the complications that will arise due to recession and on the tools that will be used by central banks. In our opinion, bankers will use radical tools (seen so far only in Japan). Their goal is, after all, high inflation, while precious metals, commodities and mining companies perform best during the period of rising inflation.
Finally, one more remark - the last period was very good for gold and mining companies. Silver, however, was slightly lagging. As a result, "gold to silver ratio" increased to 92, which means we can buy 92 ounces of silver for one ounce of gold. Today, silver is extremely cheap relative to gold, but we have no doubt that it is a matter of time when we will see rally of both metals.
It is also worth noting that when in the past gold to silver ratio reached high values, a great period for precious metals began. In the chart below, we marked such moments using red arrows.
In conclusion, if over the next few days gold survives in good condition, then in the following weeks we can see an attack in the proximity of 1,500 USD per ounce. In turn, break out of silver drags on in time, but when it comes, many people will drop their jaws.
Independent Trader Team