It has been a rather volatile couple of days in the financial markets. Much of the volatility has been in the stock markets where the major indices rose sharply late in the day yesterday after the EU and U.S. diffused their trade disputes, only for the optimism to be met with a heavy 20% sell-off in Facebook shares in extended hours on the back of the social network’s poorly received earnings report and forward guidance.
The news hit other tech stocks, although better earnings results elsewhere, including from Total in Europe, have kept most stock indices firmly in the black. Unsurprisingly, it was Germany’s DAX, which had been hit the hardest on trade war concerns, to stage the strongest relief rally as shares in carmakers jumped. Donald Trump and the EU’s Claude Juncker yesterday agreed to work on removing all tariffs, trade barriers and subsidies on many industrial goods. Although short on detail, investors have welcomed the news for the time being.
The focus is now turning to the European Central Bank, which decided a few moments ago to keep policy unchanged and reiterated that rates will remain “unchanged at least through summer of 2019.” While the euro will obviously be in focus ahead of, during and after ECB President Mario Draghi’s press conference, it is also worth watching gold prices, which tends to move in line with the euro/U.S. dollar (EUR/USD) exchange rate.
After all, the two assets have a strong positive correlation with coefficients of +0.62, +0.86 and +0.83 over a three, six and twelve month periods, respectively. So if the EUR/USD currency pair were to make a big move later on today, then so too should buck-denominated gold. On a year-to-date basis, XAU/USD has fallen about 6.0% while the EUR/USD has dropped just 2.5%. The euro has performed better than the precious metal because of the fact investors have sought the higher yielding currency and still found better value in the stock markets. But in the event of a rise in risk aversion, gold could perform much better and close the gap on the EUR/USD. This won’t be entirely surprisingly with Facebook serving as a reminder of how overvalued some stocks are. Ultimately, though, it is the dollar that will determine which direction gold goes and it remains to be seen whether tomorrow’s US GDP will break or re-establish the dollar’s short-term bullish trend. If the dollar goes up then buck denominated gold should go down.
The yellow precious metal is still not showing any signs of a major comeback although it has bounced back a little over the past few days. As a minimum before turn bullish on the metal, the first of the two bearish trend lines need to break at $1,235 per oz. Ideally, though, we want to see a break in market structure of lower lows and lower highs. With the most recent high being around the $1,245/48 area, we would turn bullish on gold should it climb above this resistance zone in the coming days. Otherwise, the path of least resistance would remain to the south and exposed to a potential drop to $1,200 support next.