Precious metals: The temporary recovery in the US dollar triggers a second round of profit taking

Precious metals prices suffered from profit taking after the US dollar rebounded against the euro at the beginning of the week. The stronger US currency weighed on gold prices and activated many technical barriers.

This in turn saw prices tumble to their lowest since the third week in January. Gold prices fell temporarily below the USD 900 mark, while silver prices, which lost the most during the week, fell to around USD 17.50. Platinum and palladium prices are trading around USD 1,990 and USD 440, respectively.

The latest declines in the gold price were, as already mentioned, triggered by a sharp rebound in the US currency against the euro. This once more highlights the effect of the high correlation between the two assets which has been increasing since the start of the sub-prime crisis in August 2007. The correlation between the EUR/USD exchange rate and the gold price is now back at elevated levels, and lately, the correlation between gold and crude oil has been increasing as well due to the massive inflow of liquidity into the commodity markets.

Investors have been buying commodities as a hedge both against the declining US currency and higher inflation, which has generally increased correlation between commodities. However, as we already pointed out in previous issues of the Research Weekly Commodities, the inflow of liquidity coupled with an upsurge in speculative positions also saw volatility rise. This is due to the high non-commercial positions that make gold prices quite vulnerable to short-term profit taking, like the ones we have seen lately.

However, from a fundamental point of view, the situation has not changed. The financial market environment is still favorable for precious metals, and especially, gold. The decline in US interest rates that has led to negative real interest rates in the USA is supportive for the gold price. Additionally, our economists expect that the US dollar should continue to weaken, particularly versus Asian currencies, while inflation concerns should bode well for gold prices. Consequently, we expect investment demand to remain high. On the physical market, however, we have seen a weakening in jewelry demand due to the high prices. However, from a seasonal perspective, we are in a period when jewelry demand for gold is low and thus prices are likely to decline. We expect prices to be better supported by jewelry in the third quarter ahead of the holiday and wedding season in India. Moreover, we project global gold production to decline, which should also augur well for prices.

Overall, we have been expecting some profit taking due to the high net speculative long positions that were in the market. However, we see this price dip as an attractive entry opportunity since we expect prices to be well supported by the tight market situation and the strong investment demand for the yellow metal. However, the main risk for gold prices is in our view an unexpected strong recovery in the US dollar.

source: CS