Gold $1,363 on Inflation, Weak Dollar; Kung Hei Fat Choy!

Year of the Brown Earth Dog
Chinese Lunar New Year 2018

Friday, February 16, 2018 AM

Kung Hei Fat Choy Miners!

Today is Chinese Lunar New Year. The Year of the Brown Earth Dog - better give Rover a treat. It is also an important time for metals shiny and red. Chinese traders will be away from their desks next week but when they return from partying we should get a good read on where gold and copper are headed for 2018.

Key drivers this week were a weaker U.S. dollar and hotter-than-expected number for the Consumer Price Index (CPI). On Valentine's Day the CPI was reported at a 0.5% in January and reported "well above expectations" (0.3%).  The updated CPI on a yearly basis is 2.1%.

The rise in consumer prices is a gauge of inflation and often proves a double-edged sword for gold. Traditionally, the yellow metal is considered an inflation hedge. This was the behavior Wednesday when gold jumped on the news and worked up to a week high of $1,363.4 per ounce early this morning. However, higher inflation could lead the U.S. Federal Reserve to hike interest hates more aggressively - potentially a serious headwind for gold. Comex gold is presently trading a bit lower at $1,355.1 but still up a healthy 2.8% for the week.

It is important to remember that gold is fundamentally driven by "real rates" or the difference between nominal interest rates, say the 10-year Treasury yield, and inflation expectations. If this difference is near zero or negative, gold is viewed favorably by investors. As the inflation number was reported the 10-year made a day high of 2.93% - ouch! You may remember that last year, the 10-year lingered for the most part below 2.4%. We have a dog race going on here, pardner.

Interest rates and inflation numbers going forward are greatly influenced by central bank policy worldwide. My latest Kitco commentary discusses what some of the moving parts are as well as useful indicators - watch the U.S. Dollar Index (DXY) and euro/yen cross rate:

The Gartman Gold Trade Revisited (Kitco News, 2/14/2018)

Several of the charts in this column are updated below.

Have a fun weekend!

Scorecard 

Here's our scorecard on where we stand for the last six months:

Intraday highs on the Comex futures exchange: 

Gold $1,370.5 per ounce January 25, 2018 (February 2018 contract)

Silver $18.360 per ounce September 8, 2017 (March 2018 contract)

Copper $3.3220 per pound ($7,186 per tonne) December 28, 2017 (March 2018 contract)

Comex copper is presently trading at $3.2475 per pound, only 2.2% below December's high. Improving global growth has kept the red metal above the key $3 per pound level with an added boost from passage of Tax Reform and expectations for U.S. infrastructure spending. China growth prospects appear to be firming up with a better-than-expected Q4 GDP of 6.8%. This results in a GDP 6.9% for 2017 compared to 6.7% for 2016.

LME inventories are building even stronger as we start a new year: 

It is instructive to keep our eyes on the Comex inventories which are now behind the LME (225,840 versus 333,625 tonnes):

My Input to Kitco News 

Here's how I saw the weekly price action as told to the Kitco News Weekly Gold Survey:

My vote is down. Target gold price $1,370 per ounce. Target Silver price $17.0 per ounce.

Transitioning from a period of low price volatility, it is likely that gold will move higher next week as Chinese gold traders are away from their desks for their Lunar New Year celebration. I believe the yellow metal will test but not exceed January's $1,370.5 per ounce high (April contract).

Gold gapped higher this week on a hotter-than-expected U.S. CPI print and falling dollar, this in spite of 10-year Treasury yields peeking above the 2.9%-level. The U.S. Dollar Index,or DXY, has returned to levels at the end of the Federal Reserve's aggressive quantitative easing programs in October 2014. If the dollar rebounds and rates continue to rise, the recent gold rally could quickly fade.

In general, commodities are rising on the heels of global growth. Although gold rose an impressive 2.8% for the week it was outpaced by copper scoring a stunning 6.5% pop. The lustrous metal also lagged companion silver, oil and the broader Bloomberg Commodity Index (BCOM). Gold led major currencies euro and Japanese yen. Gold slipped in value, albeit not dramatically, to recovering domestic equities.

Relative to the embattled S&P 500, gold retreated only 1.5%. It retains a sizable gain accumulated during the violent stock market correction - over 6% above its mid-December low (Comex gold-to-S&P500 ratio). [see Summary Chart & last graph below, Chart to Watch].

Additional Note:

The fate of the Chinese yuan remains a key tell for gold and copper - a material drop in valuation could boost gold and depress copper prices. The yuan stabilized below 7 USD/CNY for 2017 and has been trending steadily stronger in the new year. The yuan is closing for holidays weaker than last week at 6.3437 USD/CNY but set a new low February 7 (i.e. even stronger level) of 6.2540. A 1-month yuan volatility of 1.21% is in the ballpark of major currency levels - a healthy sign for the Chinese currency (1-month volatilities of euro, yen and gold*).

* the euro & yen 1-month volatilites are  0.58% & 1.13% respectively; Comex gold 1-month volatility is a very calm 0.97% (expect this to rise).

Weekly Summary  for February 16, 2018 AM 

(click on table for larger size)

Yearly Summary for 2017

(click on table for larger size)

Comex gold gained nearly 14% for the year but was outpaced by Comex copper that enjoyed a 32% uptick in price. Comex silver lagged both for a  respectable 7.2% gain. Overall, gold gained 12% on the broader Bloomberg Commodity Index (BCOMTR:IND) which includes everything from crude oil to things that oink. In terms of major currencies, gold in terms of yen advanced almost 10% but slipped 0.4% relative to the strengthening euro.

Although gold slipped 5% in value relative to the S&P 500 it was not a bad year at all for the yellow metal!

Gold Price Outlook for 2018:

My revised gold range for 2017 was $1,250 to $1,400. We closed 2017 comfortably above $1,300 at $1,309.3 (February contract).

Let's assume 2018, like 2017, is a mix of buoyant market expectations and rising rates with occasional geopolitical, political and economic shocks. Gold will feel the headwinds of the former and enjoy price spikes in times of market stress. I believe this will secure a price floor in the $1,200 to $1,250 range with highs challenging but not exceeding $1,380 per ounce.

2018 will prove a less bullish period for gold than last year unless interest rates return to 2017 levels and copper prices fall - a less likely scenario given the recent rise of the 10-year Treasury together with U.S. growth and synchronous global growth expectations. Inflation will be another key factor to monitor, there are growing signs it is on the rise (i.e. latest CPI report, above).

Here's a good beer bet for 2018: Gold will fall below $1,220 before rising above $1,380. We ended 2017 n the middle of that range with prices just above $1,300 - a fair starting point. 

Which side of this bet you take depends on whether you have a half-empty or half-full view on interest rate direction and economic prospects, both global and domestic.

Two important charts to watch remain the gold-to-S&P500 or AUSP (see "Chart to Watch" below) and gold in terms of major currencies euro and Japanese yen (directly below).

Click on the image for a larger size:

Gold in euro & yen terms with good margin above 2013 lows

Gold euro/yen spread contracts in 2018

Note for currency buffs: Value parity in the above chart occurs when the EUR/JPY cross rate is 139.24; something to watch for - presently 132.28 yen per euro and trending lower.

Chart to Watch

Here's a chart to watch for 2018. Click on the image for a larger size:

Gold-to-S&P 500 Ratio

An important gold ratio is gold-to-S&P500 or AUSP. The ratio bottomed in early-December of 2015 and reversed to a bullish trend, peaking February 11, 2016. It bottomed again December 20, 2016 (0.4973) trended higher but then bearishly bottomed again in July, 2017 and more recently December, 12, 2017 (0.4661). Currently this AM the AUSP is 0.4597, down but close to the key 0.5-level.

Cheers,

Colonel Possum & Mariana

Photos by Mariana Titus if not otherwise noted.