One aspect of recent market action over the last month is that gold has returned to a cameo role, appearing to limber up vigorously on the sidelines after a lengthy period in the sin bin. Despite the fact that it has lost ground this week, gold is approaching a potential tipping point, which could determine whether or not it can pull off the unexpected and regain a spot in the investment A team.

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There’s some major re-thinking going on in financial markets at the moment. One of the big variables up for reconsideration is US monetary policy.

This goes beyond the basic question of whether the US Federal Reserve will delay its first move due to stockmarket volatility. One of the other features of the world market landscape over the past couple of months has been the persistent decline in a range of commodity prices.  This is happening against a background of concerns about China’s growth and is fuelling market doubts about whether Fed rate hikes will be even slower than the glacial pace previously included in consensus forecasts.

Inflation may yet be a sticking point for the Fed. There’s plenty of spare capacity in world economies. Falling commodity prices are a symptom of this and are a negative for the inflation outlook. In this environment, if the Fed is too aggressive about rate hikes, it runs the risk of importing more downward pressure on prices via a strong US dollar.

This means that this weekend’s speech by US vice chairman Stanley Fischer on inflation developments has the potential to be an important one for markets generally and gold in particular. If there are indications that the Fed has reservations about commodity prices and inflation, the result could be US dollar weakness and gold strength.

The gold market has had very little to celebrate prior to the past month’s rally. The World Gold Council Report on global demand in the June quarter provides pretty clear insight into why. Compared to the same period last year total demand fell 12 per cent to 915 tonnes. The breakup was:

Jewellery down 14 per cent to 513 tonnes
Investment down 11 per cent to 179 tonnes
Central Bank buying down 13 per cent to 137 tonnes
Technology (dentistry and electronics) down 1 per cent to 85 tonnes

Jewellery demand is a big component of total gold demand and deteriorating economies in some traditional gold buying countries such as the Middle East and China could be a negative for a while. However, investment demand tends to be the big swing factor. While jewellery demand last quarter was 11 per cent below the five-year average, investment demand was 45 per cent below. Investment demand is the major source of short-term price moves and if we are going to see a further rally of any significance in the short term, investor thinking on the Fed and US dollar is likely to be the reason.  

Gold chart

All this leads me to the gold chart that I featured in an article in June. At the time, gold was looking as though it may be forming a wedge formation as outlined by the blue lines on the chart below. This pattern is still very much a possibility and has now got to the really interesting stage.

A falling wedge consists of two declining support and resistance lines. These patterns often make up the final stages of an Elliot five-wave decline and gold’s descent from above $1900 looks as though it fits this bill. In this situation the text book wedge pattern makes five touches of the support and resistance, including three bounces off the support.

As things currently stand, gold will need to rally from here to complete this pattern by confirming the last rejection of the wedge support. In theory that will set up for a significant upward move in the gold price. A break above the wedge resistance would be a bullish indicator. However, in the meantime, a move above month last month’s high of around $1175 would also be a positive sign. If that happens, the trend on the monthly chart below would change from down to up. Monthly candles would be making higher lows and higher highs suggesting the wedge support was being clearly rejected.

All this is happening at a time when the gold market is oversold, as indicated by the stochastic indicator in the box below the chart. This provides insight into the possibility that any rally could be fuelled by catching the consensus opinion on the wrong side in the early stages.

Despite all this, it’s a watershed point for pattern traders on the gold chart. If gold fails to reject this wedge support, continued downward drift is in prospect.


Business Spectator