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Chris Weston, Research Analyst, IG

Gold is one of the hottest topics right now, with the precious metal making an all-time high in EUR terms earlier in the week and now new yearly highs in USD terms.

The correlation with EUR/USD is as strong as ever, and the fact that EUR/USD has found good buying support each time it tested the 200-day moving average is positive. With momentum tools looking positive, the pair could target the recent highs of 1.3178 in the short to medium term. This should support flows into gold.

Technically, a weekly close above the November high of $1802 would be positive for the metal and suggests a target of $2050 in the months to follow. The February high of $1790 has now been breached, and it will be interesting to see how influential the bears are at $1802. In theory we may need to see EUR/USD make a convincing charge towards 1.31 in the short term, which could inspire some further confidence in gold. If we do see a break of $1802 it will be very interesting, at least from a tactical standpoint, if we see a quick spike up as stops get triggered, however we would advocate waiting for a daily close (even better a series of daily closes) to really feel convinced of a break-out above the November high. As the chart shows, gold has reclaimed the multi-year uptrend that it broke below in May and this could act as support if we see a pull-back.

From a fundamental stand-point it is positive to see a pick-up in physical buying, with many of the investment banks reporting strong flows. The strength seen in the Indian rupee has possibly helped Indian demand, and while we have heard of strong inflows into gold ETF funds and futures buying, until recently this had not been backed by physical buyers, and it seems this is now happening which should be viewed as positive.

The upcoming US non-farm payrolls are clearly the short-term catalyst for the metal and will most likely take its cues from EUR/USD. Consensus currently stands at 115,000 jobs created, however while we think a better-than-expected jobs number should aid risk appetite and therefore push up EUR/USD and subsequently gold; the difficulty comes with interpreting a poor number. On one hand it feeds into the view that the Fed can be more aggressive with future stimulus (which again is gold positive), but on the other it helps Mitt Romney’s cause as it highlights the current weakness in the US economy. Mitt Romney adopts a strong USD policy and has been an outspoken critic of Fed Chairman Ben Bernanke’s easy money policy, therefore from a political sense you could make an argument that a weak number could in theory be USD positive.

Our trading instinct however (at least from a simplistic standpoint) tells us that gold could rally on a good number and fall on a poor one, despite the political implications or further monetary policy actions.

The other clear driver at least from a longer-term standpoint is the correlation between gold and the Fed/ECB’s balance sheets. As you can see from the chart, with both central banks aggressively expanding their balance sheets, backed up by negative real interest rates (i.e. inflation is higher than the cash rate) in many other stgeloped economies, gold should continue to find buyers as a store of wealth. This will be something that will keep the gold bulls adding to positions.

Chris Weston, Research Analyst, IG