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Gold Is Down, But That Doesn’t Make It a Buy

Any trader who has been watching the performance of gold and gold stocks during the past few days has to be salivating. The SPDR Gold Shares (GLD) has fallen to $119 from just above $126 in mid-August, while the Market Vectors Gold Miners ETF (GDX) has declined more than 12% in that same interval.

Traders know that when gold and gold stocks fall sharply, it often pays handsomely to get long and wait for the bounce. But this time, there’s a substantial danger to taking the contrarian side of the gold trade.

Here’s why.

The Almighty Dollar

The key reason for the downturn in gold has been the strength in the dollar relative to the euro. European Central Bank chief Mario Draghi eased the region’s policy again last week, and it appears quantitative easing is a foregone conclusion given that inflation in the region continues to fall.

With the Federal Reserve wrapping up its own QE program and on track to raise interest rates at some point in 2015, the monetary policies of the two regions are clearly moving in opposite directions.

And, as a consequence, so are their currencies.

FXE, 1-Year Chart

FXE, one-year chart

That’s not all. The dollar also has the benefit of a huge interest-rate differential with its European counterparts. While the U.S. two-year yield closed at 0.55% on Thursday, the German two-year bund was in negative territory at -0.08%. This disparity expands across longer maturities, which continues to fuel demand for U.S. Treasuries — and therefore U.S. dollars.

It’s true that these are known issues, but they’re also issues that are going to be in place for quite some time. If anything, the gap in interest-rate policy and bond yields is likely to expand further rather than decline — a trend, obviously, that would provide a continued boost to the dollar.

As long as this headwind remains in place, it will be extremely difficult for either gold or gold stocks to gain ground for a sustained period of time.

Another potential issue for gold is the general weakness in the overall commodity markets. On Thursday morning, the PowerShares DB Commodity Index Tracking Fund (DBC) — a broad measure of commodities’ performance — broke support and fell to its lowest level since 2010. This is largely a function of weakness in oil and grain, and gold can certainly move independently from other commodities.

Over time, however, gold tends to have a high correlation with the broader commodity market — meaning that to some extent, its fortunes are tied to an asset that is on the verge of experiencing a significant breakdown.

DBC, 5-Year Chart

DBC, five-year chart

GLD itself is in a tough spot here as well, having broken its support of late June and looking to be on track for a rendezvous with the $115 level before long. The ETF last traded below this level five years ago, meaning there is little to keep the downside from accelerating if it can’t hold at $115.

GLD, 1-Year Chart

GLD, one-year chart

Bottom Line

Gold and the related equities look tempting here, but the upside is limited given the potential headwinds. Short-term rallies are certainly possible, but this is no time to be a hero. The factors currently supporting the dollar indicate the name of the game right now is limiting position sizes and taking profits quickly if the asset class experiences any upside.

Gold has been a painful trade for two years now, and that doesn’t appear likely to change any time soon.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2014/09/gold-stocks-gld/.

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