The gold market is trading slightly lower in early action Monday as the new trading week gets underway. The market appears to be digesting recent gains, and a period of sideways price action is to be expected.

 

Recent strength in gold has lured in fresh buyers while also causing some market participants to scale back on bearish positions. According to recent data from the CFTC, large speculators have trimmed short positions by a significant amount over the last two reporting periods. This shift, uncoincidentally, comes at a time when stocks have seen heavy declines and a rapid rise in volatility.

 

Recent equity market volatility has been fueled by a number of factors. Higher bond yields appear to be playing a major role in the sell-off, and rates could still have room to run even higher. Worries over the Chinese economy and ongoing war on trade are also not doing stocks any favors. It is unclear whether or not markets have simply entered a needed correction, or if this is the beginning of something bigger. Many indexes have broken down below key moving averages at this point, however, and the burden may now be on the bulls to step in and buy the recent dip.

 

The gold market has clearly attracted byers as risk aversion has been on the rise. The strong gains in gold seem to be in direct correlation with equity weakness, which also begs the question of whether or not the rally in gold is sustainable. It stands to reason that additional equity downside could propel the yellow metal higher, although it is unclear how gold may react if stocks begin to recover as many analysts have suggested will be the case going into the end of the year.

 

In addition to an equity recovery, the dollar index may also play a key role in the months ahead. The greenback has weighed heavily on the metal in recent months, and could see further strength in the months ahead. With the Fed seemingly intent on raising rates further, it is difficult to come up with a scenario in which significant dollar weakness is seen until the policies of other major central banks converge with the Fed’s. Any geopolitical flare ups or some significant cracks being seen in economic data over the next few months could, however, potentially give the Fed reason to rethink its plans for another three hikes next year.

 

Although gold has seen some significant upside in recent weeks, the real test for the market will come as stocks look to stabilize. If the market is able to hold recent gains, investor mentality may switch from sell the rallies to buy the dips. The overall technical picture has improved dramatically, however, the market may need to see a sustained move above the $1245 area in order to attract more longs. Not only would such a move higher fuel fresh buying, but it could also be the catalyst for a much larger short-covering rally. On the flip side, the market may need to hold the $1215-$1220 area on the charts to avoid falling back into its previous trading range.