Over the last week, the gold price fell 2.3% (to $1201), under-performing oil (up 2.8%) copper (down 0.1%) and the DJ UBS commodity index (down 1.7%). It outperformed silver which was down 5.9%. The fall in silver price was a significant driver of the fall in gold’s fair value over the week, analyzed in the graph below:
However, the decline in gold’s fair value (1.5%) was less than the drop in price and such a disparity would normally be a signal to buy gold short term. Taking positions based on disparities between fair value and price change of gold over the last 90 days would have yielded an annualized gain of 71% with volatility of 19%.
Our assessment of gold’s fair value lies 5% below the current price – however taking positions based on this signal of under/over valuation would have generated marginally negative returns over the last 90 days – hence we are inclined to discount it.
We can triangulate with our signal based on the lead given by the change in the (Baltic Dry Index) of raw material shipping freight rates. This index is widely seen as a leading indicator of world economic growth, with increases viewed as bullish and conversely. Unsurprisingly, we found a negative correlation between the gold price and the BDI over the last six years. Given the 29% drop in the BDI over the last month, this could foreshadow a short term increase in the gold price.
Trading this signal would have yielded a 20% annualized gain with volatility of 17% over the last six years.
Watch for Volatility
The upcoming week in the month has historically seen above average volatility of the gold price, with volatility over the last three years of 23.6% vs 17.2% for all weeks.
The graph below shows the sensitivity of gold’s fair value to various drivers –
Given gold’s sensitivity to the US CPI shown in the above graph, watch particularly for the release of the January CPI reading on Thursday. Additionally, Janet Yellen’s testimony to Congress on Tuesday and Wednesday on economic conditions and the Fed’s economic strategy could move US dollar currency pairs, adding volatility to the gold price. Mario Draghi’s press conference on Wednesday could further impact the gold price through EURUSD.