Why is Gold Trading in a Bull Market?

Why is Gold Trading in a Bull Market?

Investment
August 18, 2022 by Editor's Desk
354
Gold prices have been in an uptrend for nearly 5 years. The trend in the cost of the yellow metal is determined by looking at the 50-week moving average relative to the 200-week moving average. There are several reasons gold is in a bull market. Prices generally benefit from uncertainty as well as adverse market
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Gold prices have been in an uptrend for nearly 5 years. The trend in the cost of the yellow metal is determined by looking at the 50-week moving average relative to the 200-week moving average. There are several reasons gold is in a bull market. Prices generally benefit from uncertainty as well as adverse market conditions. Gold is quoted in U.S. dollars and generally benefits when the dollar is trending lower. Gold is a hard asset and can be stored at home or in a bank.

Since gold is a tangible asset that can be held, some traders believe it’s a viable alternative investment to purchasing paper currency. Gold has a long history as a currency, and during the uncertainty of the pandemic and the lockdowns that followed, the yellow metal has seen appreciation. The trend in gold has been relatively smooth, but when the pandemic hit in early 2020, volatility surged higher, allowing gold prices to hit their highest levels in the past 5 years.

Gold Outperforms During Adverse Conditions

Many view gold as a “safe haven” asset. Their belief is that gold is an alternative to paper money and will hold its value during adverse market conditions. For example, when riskier assets are experiencing more than average volatility, having gold in your portfolio can provide an uncorrelated asset that will not perform like equities.

Should Gold Continue to Trend Higher

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Gold prices have been in a prolonged uptrend. On the weekly chart of gold prices, you can see that gold traded sideways through 2019 with a slight upward bias after the 50-week moving average crossed over the 200-week moving average. In late 2019, as COVID-19 started to spread through China, gold prices began to accelerate higher. Gold trading remains in a bull market with the 50-week moving average remaining above the 200-week moving average.

Gold has remained a safe haven. Investors tend to want to purchase gold when market conditions are uncertain. For example, when central banks around the globe increase interest rates to fend off inflation, that dynamic creates uncertainty. Traders that are trying to decide if it’s the right time to purchase gold might want first to determine if there could be a potential weakness in global growth, which could lead to a decline in riskier assets.

The Macro Backdrop

Following the lockdowns in the wake of the COVID-19 pandemic, inflation surged higher. To fight inflation, central banks increased interest rates to decelerate growth. Quarantines and lockdowns stalled economic output, forcing central banks to reduce borrowing rates to accommodative levels to help keep economic output growing. As demand for goods and services rose, prices rose to unsustainable levels.

Higher prices are now the target of central banks. The Federal Reserve targets 2% core inflation in the United States. The latest readings on core personal consumption expenditures, which is the Fed favored gauge of inflation, was 4.8% in June, which is more than double their target. Higher interest rates have increased the value of the U.S. dollar as interest rate differentials move in favor of the greenback.

Has Inflation Peaked?

Central banks are now focused on inflation which could have peaked. The U.S. CPI seemed to ease slightly in July, mainly because of lower energy prices. In the United States, market participants continue to price in more rate hikes in September. While the easing CPI report reduced the chances of a 75-basis point hike in September, the Fed is still likely to pull the trigger on higher rates.

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Gold Volatility Has Remained Tame

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When prices are in a smooth uptrend, the implied volatility embedded in option prices remains tame. The CBOE Gold implied volatility index shows that gold volatility spiked in early 2020 as the pandemic led to lockdowns. Following this surge in gold implied volatility, prices rallied and then continued to move higher in a smooth trend. The current levels of implied volatility are hovering near the 200-week moving average, which reflects some complacency by options traders.

What is Next?

A decline could assist the bull trend in gold prices in the dollar index. The dollar index hit a 10 year high in July 2022. Since gold prices are quoted in U.S. dollars, a stronger dollar generates headwinds for gold prices. If the dollar moves lower due to a decline in U.S. rates, then gold prices will decline in other currencies. Gold prices will then likely adjust higher to compensate for the decline in dollar value. The bull market in gold trading will likely be predicated on the future movements of the dollar and the way the world views riskier assets.

The Bottom Line

Gold prices have been on an uptrend since the 50-week moving average crossed above the 200-week moving average in 2019. With the 50-week moving average remaining above the 200-week moving average, the uptrend could be considered in place. According to the data published by the Chicago Board of Options Exchange, there has been a decline in implied volatility. The Gold VIX shows that options traders believe implied volatility will remain smooth with few surprises.

The key to continuing the bull trend in gold prices is the dollar’s relative value versus other currencies. If the dollar begins to slide, there could be additional upward pressure on gold trading, pushing the yellow metal to new highs. Since gold is quoted in dollars, a weaker dollar should increase the value of gold. Market participants should continue to watch central banks around the globe to see if there is a continued effort to reduce inflation by raising rates. Recent data from the U.S. Labor Department shows that inflation is moderating, reducing upward pressure on the dollar and help buoy gold prices.

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