FX.co ★ Commodity market finally spreads wings. Why gold stuck in the same range?

Hi everyone!

The event that traders in the commodity market have been waiting for many years has finally happened. Commodity prices have gone up sharply. The price increase between August 2020 and February 2021 has become one of the strongest in the market over the past 50 years. Experts are confident that the rally in the commodity market is likely to be long-term. However, the price of gold declined during this time period, losing 15%. Why did this happen? When will gold regain ground and grow? We are going to analyze it in this article.

Notably, the fall in the commodity market that occurred in 2020 may have been the final chord in the prolonged downward trend lasting from 2008 to 2020. This was the longest period of decline since the formation of the Jamaican monetary system. Never before has the drop in the commodity market lasted for such a long period of time. Additionally, with the outbreak of the pandemic in 2020, commodity prices have decreased to the level last seen in 1972. In other words, since the US dollar has become the man reserve currency, commodity goods have never ever been so cheap as in the year of the COVID-19 pandemic. As follows from the CRB commodity index chart (Figure 1), in 2021, commodity prices fell to the level of 100. Even now they remain below the minimum values of 1973-2015, 2.25 times lower than the highs of 2007.

Pic.1: CRB Commodity Price Index Chart

Another commodity index, the S&P GSCI Total Return Commodity shows a more dismal picture. It depicts that the maximum value of the index totaled 10,000 in 2007, while the current quote barely exceeds 2,000. The minimum level fell to 1,750. Thus, prices in the commodity market amount for 40% of the maximum prices of 2007, and at worst only for 20%. It is no surprise that the Russian economy, a commodity-oriented economy, is facing serious losses. The well-being of the citizens has also deteriorated. It is happening because the goods are sold for dollars, and in dollars, they cost at best half the price or even less.

Therefore, the commodity market is ailing. There are ten times more dollars in the financial system. Goods are worth the same as if the US dollar was tied to the gold standard. Unlike oil, gold has increased many times against the US dollar since 1970.

So, why is gold declining amid growing commodity prices and a rise in inflation? When will it recover? The answers to these questions depend on many factors, e.g. the anti-cyclical nature of the price of gold. Gold is not only a commodity but also an old financial asset that often picks the opposite trend versus one of the commodity market.

According to a study conducted by analysts of the World Gold Council, in case of deflation, which is currently happening, gold behaves approximately the same. First, it rises sharply, then lags behind other goods, and then again asserts strength against them (pic. 2).

Pic.2: Behavior of commodity assets before and after deflation period

After the outbreak of the pandemic, gold and metals began to rise, while energy and agricultural goods depreciated. After that, gold stopped its growth and dropped, while metals, agricultural, and energy products continued their growth. According to Chart 2, there is a very high probability that gold will climb higher in value than commodity goods over the next three years. At the same time, in the short term, many negative factors are weighing on gold.

The main one is the rally in the US bond market and rising global stock markets, while demand from the jewelry industry is still relatively weak. US investors refrain from investing in gold, favoring the stock market. In addition, the US and European economies are trying to soften the consequences of the epidemic. Traders in Asia are now the main gold buyers but they have little influence on the price movements of gold.

Pic.3: Technical pciture of gold on daily timeframe

In January 2021, I predicted that gold would reach the $1,680 level in one to three months (Pic. 2). As we can see from Chart 3, in early March 2021, the price fell to the predicted support level. Yesterday, it tested again the $1,680 level. Gold is likely to drop to the $1,550 level, which will spook bulls.

Last week there were sheer signs of a rise in demand for gold among US traders. Demand in futures contracts on the CME exchange began to increase. It is still very early to talk about a change in the trend. However, in case of a positive scenario, gold will begin to advance in the third and fourth quarters of this year. However, until the technical indicators show us the strong bullish signals, it is recommended to refrain from buying gold. You may buy gold significantly below the current values. Be careful and follow the rules of money management.