Traditionally the strength of gold has been tied to the strength of the dollar, with a weak dollar leading to a high gold price and vice versa, but Cieszynski says that this relationship has broken down in recent years.
The price of gold has become attached to the strength of the euro, he claims, and the stimulus measures announced earlier this month by the ECB imply a potential jump of over 50 per cent to the gold price.
“If gold continues to follow its recent trend of tracking the size of the ECB balance sheet, it could potentially stage a 56 per cent retracement of its losses over the last few years in the coming months,” he said.
“Considering that 50 per cent to 62 per cent Fibonacci retracements are common in markets around the world, a rebound of this magnitude does not appear to be out of the question.
Gold has been under pressure since late 2011, losing 36 per cent since September of that year.
Performance of gold over 3yrs
Source: FE Analytics
This has taken many investors by surprise, as the period has seen further QE by the US authorities, or money printing, which was expected to lead to inflation and a boost to the gold price.
“For centuries, gold has been seen as defensive currency, a store of value in turbulent times and a hedge against inflation in paper money,” Cieszynski said.
“In recent decades, pricing in gold (the premier hard asset) has been driven by its relationship with USD (the world’s premier leading paper currency).”
“Since the early 1970s, gold has rallied during times of political or economic uncertainty or during times of inflation and weakened when paper money rebounded.”
“An example of this relationship has been in the resurgence of gold since the turn of the century as USD retreated.”
“Most specifically the first two QE programs ignited major rallies in gold as big increases in the supply of US Dollars depressed the value of the paper currency.”
Source: CMC Markets
“Relative to the first two programs, gold performance since the start of QE3 has been truly dismal. It also indicates that gold’s relationship with paper currencies has changed dramatically in recent years.”
“What has become increasingly clear in the last few years is that since the start of this decade, gold’s primary relationship in trading has changed from USD to EUR,” he added.
“The European sovereign debt crisis sparked major new flows of capital from Europe into gold that has changed its main trading drivers.”
Cieszynski explains that the US Federal Reserve and ECB diverged in their monetary policy in the summer of 2012.
At that point the ECB began a “stealth taper”, by which it shrank its balance sheet by €1trn over 18 months as the banks paid back their borrowings under the LTRO programme. The US Federal Reserve launched QE3 at the same time.
“Over the same time period, instead of rallying as it did during the US QE1 and QE2, gold sold off, indicating that it had started to take its cue more from the shrinking money supply and reductions in political and financial risks from Europe, than from the Fed,” he said.
Source: CMC Markets and Bloomberg
The analyst says that the sterilisation and LTRO programmes announced by the ECB this month represent a retraction of this policy and an expansion of the bank’s blance sheet.
In total the programme calls for the addition of €565bn by the end of this year, or 56 per cent of the amount taken out since 2012.
This could lead to a 56 per cent uptick in the gold price, he claims.
“This major turn in monetary policy exceeded street expectations and sparked an immediate rally in gold which may have signalled a major turning point for the yellow metal after nearly three years of declines,” he said.
Some analysts have pointed to the outbreak of war in Iraq as the source of gold’s strength, and the troubles in Russia and Crimea as supporting it in recent months – gold is up 3.48 per cent year-to-date.
However, Cieszynski thinks the dominant factor is ECB monetary policy.
“If gold continues to follow its recent trend of tracking the size of the ECB balance sheet, it could potentially stage a 56 per cent retracement of its losses over the last few years in the coming months,” he said.
“Considering that 50 per cent to 62 per cent Fibonacci retracements are common in markets around the world, a rebound of this magnitude does not appear to be out of the question.”
Cieszynski says that technical indicators also suggest a bull market in the precious metal, with gold completing a double bottom near the end of last year and showing a divergence of the relative strength indicator [RSI].
“At this point it would take a break through $1,400 to signal the start of a new recovery trend, but if gold does track the re-expansion of the ECB’s balance sheet, a 50 per cent to 62 per cent retracement of the previous downtrend suggests the $1,555 to $1.640 zone could potentially be probed over time,” he said.
