Gold’s Bullish Breakout Extends Advance Amid Yen Flash Crash

After trading sideways for two months, in early-December, Gold was able to clear out the former December 2017 low at 1236.37, having previously closed below it every session since July 17. Since the December 4 close above 1236.37, Gold has not looked back: price has closed above said level every session since then. Gold’s run higher is rooted in several factors – the US-China trade war, expectations around the Federal Reserve’s policy in 2019, and changes in energy prices, among others – but the common denominator here how Gold fits in with other assets along the risk/return frontier.

GOLD PRICE RALLY INDICATIVE OF WEAK ENVIRONMENT FOR RISK APPETITE

Unlike traditional assets like stocks or bonds whose values can be derived from dividends or coupon payments, Gold doesn’t offer a cash flow to investors. Long-term studies of interest rates and price action with respect to gold reveal that the annual cost of carrying bullion is approximately -2.4% per year. For all intents and purposes, the cost of carry could be considered Gold’s yield.

From this perspective, there are two reasons FX traders would look at gold. First, the prospect of capital appreciation, that is, greater than the -2.4% cost of carry per year. Second, when the yield characteristics of other currencies begin to resemble gold itself. To this last point, this is why movements in the Japanese Yen a negative-yielding currencies, resembles movement in Gold prices.

FALLING US TREASURY YIELDS ARE GOOD FOR GOLD…WHY?

Investing is all about asset allocation and risk-adjusted returns. On the asset allocation side, it’s about achieving required returns given the investor’s wants and needs. If inflation expectations are rapidly increasing, you would expect to see fixed income underperform: the returns are fixed, after all. Why would you want to have a fixed return when prices are increasing? On a real basis, your returns would be lower than otherwise intended.

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Disclosure: Do you want to see how retail traders are currently trading the US Dollar? Check out our IG Client Sentiment ...

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