Gold, Risk And The Currency Markets


Just a week and half ago Gold look poised to test the 200 day moving average. However, after 8 straight sessions in the black, Gold retook the 100 day MA and has now tested the 50 day MA twice on intra day moves before closing lower. Gold is bid aggressively during times of economic uncertainty. If Gold can get a solid close above the 50 MA, it will likely, once again retest all time highs. If however, Gold fails to retake the 50 day MA it will most likely retest the 200 day MA near 1,155.


If Gold in fact closes above it’s 50 day MA it will suggest that risk aversion is leading the markets. The strong correlation between risk aversion and the price action on the USDJPY implies that the JPY may fall further. However, the JPY has found stiff resistance below 85. The set up suggests that if Gold trades higher due to risk aversion then the JPY will be forced lower with strong momentum. The strength of momentum will have to be stronger than that of Resistance at 85. Look at the number of long down candles with long lower wicks which tell us that momentum strength has been strong enough to plow through Resistance several times on 2010’s volatility. If the same set up repeats itself expect to see major price action, a long candle with a long lower wick as the JPY will attempt to crach through Resistance due to strong market risk aversion.


The reason behind the JPY’s correlation to recent Gold price action and its measure of risk aversion, is tied to interest rate differentials or the Carry Trade. The Bank of Japan keeps their interest rates low which means investors will borrow JPY and exchange it into a currency yielding a higher rate of interest such as the AUD. A traders position is then financed by the JPY at 0.10% as he went short JPY. The long AUD position represents his investment, as he invests at 4.50% However, when risk is at elevated levels the change in currency prices can more than offset the interest rate differential. Therefore when risk aversion peaks traders will cover their short JPY, causing the JPY to appreciate quickly. Extreme volatility expresses the level of risk in the market. That being the case whole picture become clear when you observe price action on this pair going back to November of 2009.

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