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Changes in the size of the "end is nigh" sandwich-board sign crowd – the percentage of the investing public concerned that the global financial system was about to implode – have been the primary drivers of the gold price over the past five years. Unfortunately, the Census Board doesn't quantify their ranks so we're left with technical analysis (as a way to measure sentiment), and the value of the trade weighted U.S. dollar (DXY) as the best tangible means to gauge whether gold is expensive or not.
In U.S. dollar terms, the gold price jumped $30 (U.S.) or 2.2 per cent Thursday. The chart above shows where we stand now.
The correlation between gold and the DXY, using 36 months of daily data, is currently –24. This is well below the generally accepted –75 to –85 range used as the longer term rule of thumb. (Events in late 2010, when both moved higher, seem to be the cause of the anomaly). The usual inverse relationship – gold up, dollar down or the reverse – remains intact.
The acceleration of the sell-off in gold that began in March 2013 does look disproportionately large relative to the rise in the greenback. By the end of June, the relative strength index (RSI) for gold – my current favourite technical indicator – was in massively oversold territory, below 20 (the 30 level indicates oversold, 70 implies overbought).
The 14 day RSI for the gold price, now 63.3, is approaching overbought territory after yesterday's rally.
As always, investors tempted to add to precious metals holdings need to pay close attention to changes in the U.S dollar exchange rate. The dollar has been much more volatile than usual in 2013, so it's even more important to watch it now.
The stakes are high – this is a do or die moment for a lot of gold mining companies and specialist asset managers. A number of businesses risk failing if yesterday's move in gold is only a temporary technical snap back and the downward trend resumes. Thankfully for them, Fed-related tapering fears are currently helping – rising interest rates are threatening to throttle U.S. economic growth, and dollar-denominated assets are looking arguably less attractive than they were just a few short weeks ago.
The gold price, as I mentioned, is largely sentiment-driven and this makes forecasting price moves more difficult – sentiment can easily become extreme. Now, with the RSI creeping up on levels suggesting excessive short term optimism, investors in the sector should tread lightly and keep the U.S dollar in mind at all times.
Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights , and follow Scott on Twitter at @SBarlow_ROB .