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3 Valuable Forex Lessons from Gold’s Collapse

Kathy Lien

Following massive losses in gold on Monday, currency traders should observe a few important takeaways, including the impact of the move on inflation, upcoming data, and technical cues.



There were some big moves in the foreign exchange market on Monday, but nothing compares to the selloff in gold. In fact, simply calling gold’s move a “selloff” is an understatement because the 8% decline is the largest single-day loss for the commodity in three decades.


While gold is also considered a form of currency, it is a truly global commodity that is affected by broader and less country-specific factors than traditional fiat currencies backed by individual governments. Therefore, big moves in gold can be an important signal for currency traders.


On a daily basis, gold may take its cues from the market's demand for dollars, but this time around, the selloff in gold is sending a very strong message about investor appetite.


For the past few years, buying gold as an inflation hedge was one of the most popular trades championed by some of the most respected investors around the world. Unfortunately, as time progressed, patience began to wear thin and investors were seeing their investment values dwindle with no hope of rapidly rising inflationary pressures in sight.


Consumer and producer price reports also failed to show any major uptick in price pressures, as weak demand prevented businesses from raising prices. Tuesday's US consumer price report should show how benign inflation pressures have been in the US, as CPI is expected to have stagnated in the month of March.

UK and Eurozone consumer price reports are also scheduled for release, and while price pressures have been stronger in both countries, there is still more downside than upside risks. As a result, with returns in equities becoming more attractive, a larger subset of investors are giving up on their losing inflation hedge and going on the hunt for yield.


The selloff in gold also reflects concerns about global growth. Between the softer US economic reports, weaker Chinese data, and this month's disappointing US retail sales and jobs numbers, there are definite signs that the global recovery is losing momentum.


See related: 3 Economic Red Flags…and One False Alarm


The US dollar traded higher against all major currencies on Monday except for the Japanese yen (JPY) on the back of weaker manufacturing activity in the New York region (the Empire State manufacturing index dropped to 3.05 from 9.24) and a decline in foreign purchases of US Treasuries.


Finally, $1,500 was a key support level for gold, and when that broke, the selloff quickly gained momentum. Stops were triggered, margin calls were made, and many investors opted to abandon their losing positions then to add margin.


For forex traders, there are a few important takeaways from the move in gold: 1) There's no need to worry about inflation until there are significant and sustainable signs of growth; 2) Be worried about the slowdown in China and the US; and 3) Beware of how quickly losses can occur when key levels and stops are taken out. In terms price action, these concerns could lead to further pressure on major currencies.

Latest German Data Looms Large for Euro


Compared to other major currencies, the euro (EUR) has been surprisingly resilient. The NZDUSD was down 2% on Monday, and yet the EURUSD was down only 0.5%. A large part of this had to do with better-than-expected Eurozone data (see the complete economic calendar).


The region's trade surplus rose from 8.7B to 12.0B in the month of February thanks to an increase in exports and decline in imports. Nonetheless, the euro is still under pressure, and until resistance at 1.3150 is broken, the currency is vulnerable to additional losses.


The German ZEW survey, a measure of investor confidence, is scheduled for release on Tuesday, and a disappointment could accelerate losses in EURUSD. Economists are looking for a sharp pullback in confidence, and we believe that this is likely considering that Cyprus and Italy posed a risk for the Eurozone in the month of March.


German data was also very mixed, and the cracks in the Eurozone's largest economy have begun to show. The ZEW survey may be the most important economic report expected from the Eurozone this week, but European politics are also in focus.


Italian lawmakers will begin the process of electing a new President this week, and how those discussions go will be a reflection of the current government's ability to work together. There is still no timetable for selecting a Prime Minister, but choosing a President will be an important next step.


British Pound (GBP) Could Get an Upside Surprise


The British pound (GBP) also fell victim to risk aversion, but its losses were the most limited of the major currencies. Part of the reason for that could be the expectations for stronger UK consumer prices this week.

This is a very busy week for UK economic data, and based on the outcome of the reports, the GBPUSD will either extend its losses or finally break above 1.54. The 2.1% rise in the Rightmove House Price Index was encouraging, but it was not enough to get sterling traders overexcited.


Tuesday’s consumer price index is one of the most closely watched pieces of economic data for the Bank of England (BoE). If you recall, when the BoE minutes were last released, we learned that the central bank overlooked slower growth because of their concerns about inflation. Economists are looking for CPI growth to slow, but based on an increase in shop prices reported by the British Retail Consortium (BRC), there is room for an upside surprise that could drive the GBP higher.


Will the RBA Minutes Save the AUD?


Monday’s worst-performing currencies were the Australian (AUD) and New Zealand dollars (NZD), but the Canadian dollar (CAD) also fell sharply. The combination of lower gold prices and weaker Chinese data washed out the longs.


Having broken through a series of support levels, the only hope for AUD and NZD are the ReserveBank of Australia (RBA) meeting minutes due out Monday night. Data since the last meeting has been mixed, so the RBA's view may not have changed very much.


At the last meeting, RBA Governor GlennStevens maintained a glass-half-full view of the economy, and if he holds onto this stance, it could lend support to both the AUD and NZD. If there are any signs of renewed concern, however, we could see steeper losses in both currencies.


The problem is that China is beginning to feel the pain of economic overexpansion, as slower growth in fixed capital investment, industrial production, and retail sales start to weigh on GDP. China's economy expanded at an annualized rate of 7.7% in the first quarter, down from 7.9% in Q4.Considering that most economists were looking for faster growth, this pullback caught everyone by surprise.


Despite strong credit growth, a higher luxury tax, smaller increase in disposable income, decline in government spending, and softer inflation all caused consumer spending growth to slow in the first three months of the year.


The question now is whether the weakness in Chinese data will prompt the People's Bank of China (PBoC) to consider shifting from neutral to easier monetary policy. We believe that the central bank will want to see if the slowdown is sustained in the second quarter before they change interest rates or the reserve requirement ratio, so AUD and NZD traders shouldn't expect any help from the PBoC in the interim.


USD/JPY Falters on Renewed Risk Aversion


The USDJPY extended its losses as risk aversion hits the currency. Monday’s selloff in US stocks and the softer Chinese economic reports may have contributed to a general sense of anxiety and nervousness in the markets.


Short yen traders also reacted negatively to a report from the US Treasury released late Friday. In the semi-annual report on currencies, the Treasury said "We will continue to press Japan to adhere to the commitments agreed in the G-7 and G-20, to remain oriented towards meeting respective domestic objectives using domestic instruments and to refrain from competitive devaluation and targeting its exchange rate for competitive purposes."


Some investors interpreted this to mean that the US is critical of Japan's policies, but with the weaker yen being a byproduct of monetary policy and not currency intervention, it may be difficult for the US to justify its position when US policymakers are also guilty of competitively devaluing the currency through monetary policy.


Meanwhile, economic data from Japan has been good, with industrial production revised higher in the month of February. We continue to expect the weaker currency and monetary policy to support Japan's economy.


By Kathy Lien of BK Asset Management


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