Why gold is looking particularly attractive in its traditionally strong season

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Gold is starting to show some strength and look like an attractive opportunity with favourable tailwinds. Investors are trying to determine if the upward trend is sustainable.

The precious yellow metal potentially bottomed on July 6 at about US$1,950 an ounce after declining from US$2,050 in early May. The rise of the 10-year U.S. Treasury’s yield from April through early July hurt the price of gold. As interest rates increased, so did the opportunity cost of holding gold, which doesn’t pay any form of distribution or dividends. (Generally, gold becomes less attractive as interest rates increase.)

Although the U.S. Federal Reserve Board may raise its funds rate once or twice more this year, investors are anticipating the U.S. central bank will at least pause its hiking schedule later this year. In other words, the Fed’s rate hikes are priced into the current gold price.

The yield on the U.S. Treasury 10-year note peaked in early July above 4 per cent and has declined to 3.8 per cent since. Gold has been responding well to that.

The U.S. dollar’s role

The strength of the U.S. dollar relative to world currencies also plays a part in the value of gold. Generally, a stronger U.S. dollar puts downward pressure on commodity prices because they’re traded in U.S. dollars.

The U.S. dollar peaked in October 2022 at more than 114 on the U.S. Dollar Index (DXY), which is a benchmark foreign exchange index that measures the strength of the U.S. dollar versus international currencies. Recently, the U.S. dollar has dipped below 100, which is a key psychological level of support.

The strength of the U.S. dollar has been fading as investors anticipate the Fed pausing its interest rate hiking schedule. In addition, the U.S. government has been borrowing and spending huge amounts of money. This process puts downward pressure on the value of the currency, which, in turn, helps push the price of gold higher.

Many central banks around the world have been buying record amounts of gold as they seek to reduce the amount of U.S. dollars held in their foreign reserves. Although the U.S. dollar may be the world reserve currency for some time yet, countries have been diversifying their transaction medium away from the greenback, putting downward pressure on the U.S. dollar.

The BRICS countries including Brazil, Russia, India, China and South Africa and an expanding list of countries that have applied to join the group, which together potentially make up most of the world’s population, are also investigating the use of gold as a backing to a potential currency. It’s expected that they will announce a formal start of developing some sort of gold-backed currency at their conference on Aug. 22.

Seasonal factors driving gold’s performance

Meanwhile, gold has just entered its strong seasonal period, which lasts from July 12 to Oct. 9. It tends to move up at this time of the year as demand increases ahead of India’s wedding season, which takes place from November through February, and religious events, including Diwali, which lands from mid-October to mid-November. Traditionally, Indians have been the largest consumers of gold; most of it is bought heading into their wedding season.

In addition, gold tends to garner support from lower interest rates that tend to occur in the late summer and early autumn. Also, volatility in the stock market tends to increase at this time of the year, which helps support gold’s status as a safe haven – and its price.

Gold has produced an average return of 3.2 per cent and has been positive 63 per cent of the time in its strong seasonal period from 1984 to 2021, according to Bloomberg LP data. During the same period, the S&P 500 has produced an average loss of 0.3 per cent and has only been positive 55 per cent of the time.

There are many variables affecting gold’s price. The more variables that provide a tailwind for gold to move higher, the greater the probability of gold performing well. Although no trades are guaranteed, gold could outperform during the next few months.

Brooke Thackray is research analyst at Horizons ETFs Management (Canada) Inc.

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