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What drives the price of gold

Fiala Petr
Published: 20.6.2014 | Last modification: 20.6.2014 11:21  | Comments: none
What are the key factors influencing the price of gold? There are a lot of various opinios from very respected authors on the internet. So here is my opinion.

I find it relatively easy. The main driver is USDJPY. When USD is weak against JPY, it is bad for carry trade and risky assets that are correlated with S&P 500 and other important indices as ^BKX ( banking index). I have found the highest correlation between USDJPY and broker&dealer index ( ^IBD, IAI). Stocks from Broker&dealer industry are the main beneficiaries of rising USDJPY and mining stocks suffer the most. 

Chart: Here are shown correlations between USDJPY - gold ( GC) and USDJPY - ETF IAI in the upper graph panel ( for 400 weeks). You can see that these correlations are quite opposite. When financial stocks are strong along with USDJPY,   gold, silver and mining stocks are weak. There is also second factor I've found important - it is demand of banks for the money. It is displayed in the middle graph panel. When the banks are optimistic regarding stocks and other risk assets, they want to borrow as much as possible from the FED and that is positive for stocks. However when the demand of the primary dealers of the FED drops to minimum, it is bad for stocks in general  and good for gold, silver and mining stocks. The stochastic oscillator in the middle graph panel shows this. This oscillator is constructed from open market operations of the FED, twice smoothed (25+25 weeks). You can see that rising demand for money manifests itself in rising USDJPY most of the time.

There is second sentiment indicator that we can track. It is sentiment of banks regarding Japanese yen. I use for this purpose COT reports ( next chart below). 

Chart: Net Short positions of Commercials ( banks) are shown in the middle graph panel in the form of 10-week stochastic oscillator.  Maximum of the oscillator shows maximum of the short positions. When banks hold maximum of LONG positions of the yen and the demand for the FED money goes to minimum ( in the upper panel), it is bearish for USDJPY and S&P 500 and bullish for gold, silver and mining stocks.  

You can see in the next chart how the demand of primary dealers of the FED is reflected in the price of EWG, which is ETF for German stocks. I have chosen EWG due to its higher volatility compared with S&P 500, you can better recognize the influence of sentiment of the banks on the markets.

Chart: It looks like a good strategy to sell stocks when stochastic oscillator ( 25+25 weeks) drops below 50. And I suspect this signal is good for gold.

How can we exploit these informations?

I think this information regarding sentiment of banks gives us an edge in relation to trading in mining stocks, gold and silver.

Chart: I have constructed an easy strategy: Buy GDX whenever RSI drops below 30 and demand of banks for the FED moey drops to minimum. You can see some signals in the chart below. Not all of the signals were perfect, however some bad signals were at least eliminated. We are in BEAR market for metals right now and if the downtrend will come to an end sometime in the future  this strategy should work well. Right now mining stocks appear to be on BUY signal along with gold and silver.

We are preparing trading models for gold stocks  on www.algotrading.cz which will use these principles. We are going to release first model soon. BUY and SELL signals are intended to be sent to customers via e-mail. At this moment you can find there models only for S&P 500 stocks and ETFs, not for mining stocks.

Petr Fiala

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