Gold Update


Last week, we warned that gold may be rolling over.  Today, it is experiencing is biggest single day drop in six months.  It has been pushed well below the August low near $1300 and has thus far recorded a low near $1281.65.  As the Blomberg chart shows, today’s drop has exceeded the 50% retracement (blue line) of the rally since the end of May.

The next obvious target is the 61.8% retracement (green line)  It is found just below $1266.90. It is just above the 200-day moving average (purple line) that is near $1257.40 and rising.

With today’s losses gold has fallen for six consecutive sessions.  This streak followed a six-session advance.   Although we remain bearish on the medium-term, we are concerned that the market may be getting a bit ahead of itself.  The price of the precious metal is now well through the lower Bollinger Band (~$1296.25), which is set at two standard deviations below the 20-day moving average.   In fact, at the session lows, gold was more than three standard deviations away below the 20-day moving average.

Standard deviations may be more relevant in time series that is normally distributed, which gold and most other markets are not.  Nevertheless, the rarity of a three-standard deviation move suggests that it ought to be respected.  This is the first time this year that the price of gold has moved beyond three standard deviations.

Even if one does not invest in gold, its sell-off may be telling us something about the broader market.  Specifically, if the market were to put increased emphasis on interest rates, and the possibility of a Fed hike before the year is out, the opportunity cost of owning gold would increase.

Yesterday Cleveland Fed President Mester, who dissented in favor of an immediate hike in September, said that a rate hike would be even more compelling in November.  We disagree and see no precedent for a hike a week before the national election.  Moreover, NY Fed President Dudley also spoke yesterday and did not share Mester’s sense of urgency.

Today, the November Fed funds futures contract implies a greater chance than yesterday of a hike.  Bloomberg’s calculation puts the odds at 21.4% chance up from 17.1% yesterday.  The CME, where the contract trades, says there is a 13.4% chance, up from 10.3% yesterday.