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Gold has gained more than 15% to just over $1,200 an ounce since hitting multi-year lows in December. The Market Vectors Gold Miners ETF (GDX) has fared even better, rallying roughly 40% over the span. The question now, of course, is what happens next.
For the most part, the factors that have propelled gold and other precious metals higher remain in place–in some cases, in fact, they have become more pronounced. For example, concerns about global financial stress–which I discussed in “Despite Recent Strength, Bonds Remain Vulnerable“–have intensified amid fears that banks and other financial institutions, especially in Europe, may be more exposed to credit-related woes than they have previously let on.
According to CNN Money, the price of insurance on bank debt has jumped dramatically in recent months. Early last week, they touched their highest levels since the 2011 sovereign debt crisis. The share prices of banks and insurers have also been pummeled. In the U.S., the KBW Nasdaq Bank index has dropped 18.5% so far this year, more than double the decline in the S&P 500 index, while the Dow Jones Euro Stoxx Banks index has plunged more than 23%.
Higher spreads become contagious
In the meantime, funding costs for the highest quality corporate borrowers have been racing higher, following on the heels of lower-quality counterparts. As Zero Hedge notes, U.S. investment grade credit spreads hit their highest levels in five years. That suggests concerns about creditworthiness, which optimists maintained were limited to energy-sector companies and highly-leveraged borrowers, are having a more far-reaching impact.
A fear of further currency devaluations and the fallout from deteriorating economic conditions have also boosted demand for the yellow metal, especially from residents of the world's second largest economy. In “Chinese Start to Lose Confidence in Their Currency,” the New York Times reports that “wealthy families are increasingly trying to move large sums of money out of the country, worried that the value of the [yuan] will fall and their savings will be worth less.” Evidence suggests that at least some of these outflows are finding their way into precious metals.
That said, safe haven buying has not been driven by economic and financial concerns alone. As I noted in “A Boiling Point…For Gold,” geopolitical, political and social conditions across the globe have been deteriorating for some time. Recent developments suggest the world may be on the cusp of something more precarious: an increase in cross-border armed conflict.
A new world war?
Among other things, Russia has “warned of ‘a new world war,' starting in Syria,” The Telegraph reported, “after a dramatic day in which [Saudi Arabia and other] Gulf states threatened to send in ground forces.” Meanwhile, Turkey reportedly fired on Syrian Army and Kurd forces in Syria, and says that a “massive escalation” is imminent. Separately, the U.S. is reportedly “on the verge” of taking action against the Islamic State in Libya.
Tensions have also been rising in Asia. Last week, North Korea launched a long-range rocket, which was widely seen as a test of ballistic missile technology, in defiance of U.N. Security Council resolutions. That country also conducted what it says was a hydrogen bomb test in early-January, spurring widespread calls for strong actions in response.
In addition, the Chinese are reportedly set to begin using new runways on man-made islands in the disputed South China Sea for military operations in the next few months,” drawing ominous warnings from a senior U.S. naval official that any such move “would be destabilizing and would not deter U.S. flights over the area.”
Less supply, more demand
The price of gold has also been bolstered by improving supply-and-demand trends. Citing data from the World Gold Council, ValueWalk notes that gold mining production fell in 2015 for the first time since 2008. The WGC also says that central bank buying remained strong in the fourth quarter, with demand up 25% from the year-ago period, while the ETF market saw a 28% year-on-year decline in net outflows.
Other reports buttress the notion that demand is rising. U.S. Global Investors CEO Frank Holmes says that “sales of American Eagle gold bullion coins reached 124,000 ounces in January, up 53 percent from a year ago,” while “physical delivery from the Shanghai Gold Exchange reached a record 2,596 tonnes, representing more than 90 percent of total global output for the entire year.” According to The Telegraph, bullion dealers in the U.K. have seen record sales, with buyers lining up around the block to purchase the metal.
Poised for a pullback?
Since the fundamentals are still largely positive, some might maintain that it makes sense to keep buying, even after the breathtaking run that has been seen so far. However, there are signs that things may have gotten ahead of themselves, at least in the short run. To be sure, markets rarely move in a straight line. Even during the biggest bull markets, there are invariably corrections along the way, often stemming from profit-taking by short-term speculators.
There is also the fact that enthusiasm for the metal seems to have reached a fever pitch in a fairly short period of time. While buying enthusiasm is a prerequisite for higher prices, history suggests that what might be described as headline exuberance is often a sign that caution is warranted. In addition, CFTC data reveals that gold shorts have decreased futures positions for six straight weeks, matching the longest run in history, suggesting that savvy traders might soon step in and fade the rally.
Moreover, many technical indicators are at bullish extremes, heightening the odds that a pullback is at hand. As illustrated below, gauges of price momentum, including relative strength index (RSI), moving average convergence divergence (MACD) and rate of change (ROC), are at or near levels that have coincided with prior peaks. The fact that gold is trading significantly above key moving averages would seem to provide additional confirmation.
To be sure, there is always the risk that a tactical decision to step aside and wait for a better entry point might not work out as planned. However, since those who have been paying attention before now would already have accumulated sizable positions–in contrast to what many others might have been doing–perhaps it is time to be a nimble contrarian once again.