Rising geopolitical tensions, declining interest rates, a weakening U.S. dollar. If one were to list the top factors that traditionally push gold prices higher, these three would undoubtedly land in the top five.
And as of mid-January 2020, gold has been seemingly caught in a perfect storm, as each of the factors listed has become a catalyst for higher prices.
Looking back at last year, interest rates took center stage when the U.S. Federal Reserve enacted three consecutive rate cuts—declining rate environment, check.
As can often be the case with declining rates, the U.S. dollar has also been losing value since last fall, as seen in the Dollar Index (DXY)—declining U.S. dollar, check.
While these two themes were playing out in the latter half of 2019, it was a critical geopolitical event at the start of 2020 that appears to have shifted the recent gold rally into overdrive.
On Jan. 3, the American military conducted a drone strike in Iraq that resulted in the assassination of Iranian Major General Qasem Soleimani. With tensions already high in the Middle East due to a wide range of thorny conflicts, the move by the United States to assassinate one of the best-known military leaders in the region has undoubtedly pushed geopolitical uncertainty several degrees higher.
Days after the U.S. military operation in Iraq, gold prices notched a seven-year high and ended trading just shy of $1,600 per ounce.
From a technical trading perspective, what’s possibly most interesting is that the recent run-up in gold comes on the heels of an already strong 12 months in the world’s best-known precious metal. Gold prices rallied consistently throughout last year, rising from roughly $1,300 per oz. at the start of 2019, all the way to $1,500 per oz. at the end of December.
With new geopolitical uncertainty now adding extra fuel to the fire, it’s hard to envision gold prices weakening in the near term, unless one of the three narratives pushing prices higher reverses course.
For reference, the all-time high in gold is $1,908.60 per oz. and was set in 2011.
As some might recall, gold prices also made headlines last year due to the soaring gold-silver ratio. Gold and silver share a strong positive correlation, so it was a bit perplexing last summer when gold prices climbed higher without silver tagging along.
Due to that temporary breakdown in correlation, the gold-silver ratio climbed to a nearly 30-year high.
Commodities and futures traders often monitor the gold-silver ratio for potential trading signals that might involve one, or both, of these precious metals.
As a reminder, the gold-silver ratio is calculated by simply taking the price per ounce of gold and dividing it by the price per ounce of silver. The quotient of that equation reports how many ounces of silver are required to buy a single ounce of gold at a given point in time.
For example, at the start of 2019, when gold was trading for roughly $1,283/ounce, and silver was trading for $15.70 per oz., that meant approximately 82 ounces of silver were required to purchase a single ounce of gold.
When gold prices left silver prices in the dust last summer, the gold-silver ratio climbed to a roughly 30-year high, at about 93. Silver prices did eventually catch up to gold, pushing the ratio back down to 80 by September, as illustrated in the chart below:
As of mid-January 2020, the gold-silver ratio is currently trading at about 90, just shy of those nosebleed levels observed last summer. The all-time high in the ratio is just under 100, and was notched in 1991. In 1942, the ratio nearly reached those same levels, topping out at 97. The average level in the gold-silver ratio over the last 20 or so years has been about 60.
Traditionally, pairs traders sell gold and purchase silver when the gold-silver ratio reaches the higher end of its range. A position such as this theoretically benefits from a drop in the ratio, which would require gold to go lower, silver to go higher, or both.
The reverse position is deployed when traders expect the gold-silver ratio to increase, buying gold and selling silver.
Of course, traders can also take naked directional positions in either gold or silver, or even trade precious metals volatility using ETF or futures options.
For a detailed rundown of the complete precious metals landscape, traders may want to review the following programs on the tastytrade financial network when scheduling allows:
- Closing the Gap Futures Edition: This Year’s Gold-Silver Ratio
- Futures Measures: Is Gold a Good Fear Gauge?
Sage Anderson is a pseudonym. The contributor has an extensive background in trading equity derivatives and managing volatility-based portfolios as a former prop trading firm employee. The contributor is not an employee of Luckbox, tastytrade or any affiliated companies. Readers can direct questions about topics covered in this blog post, or any other trading-related subject, to firstname.lastname@example.org.