Fed monetary policy has been the most significant driver of gold prices over recent years, and US employment data has been the main driver of Fed policy. Therefore, the release of US Non-Farm Payroll data is hugely significant for gold investors, and Friday's release was no exception. We have been bearish on gold prices for all of 2013, and as a result, our model portfolio is up nearly 60% year to date. However, there a couple of factors that are causing us to consider the possibility of a significant rally in gold prices towards the end of the year. Whilst our core view is that gold prices will head lower, we see a risk that softer employment data and delay of QE tapering may trigger a rally in gold over the coming months.
Let us start by taking a look at most recent set of employment data that was released on Friday. Total nonfarm payroll employment increased by 162,000 in July, which was below expectations, and saw a rally in US bonds and gold prices spiking higher. In addition to this, the change in total nonfarm payroll employment for May was revised from +195,000 to +176,000, and the change for June was revised from +195,000 to +188,000. Although the most recent number missed expectations and we saw some backward revisions, we must keep the big picture in mind. Over the last year, nonfarm employment growth has averaged 189,000 per month, much to the satisfaction of Bernanke.
It is this consistent growth that has caused the idea of tapering to be put on the table. Remember that the Fed is not concerned so much with one-off sets of data, but more with the overall trend. As the chart below shows, the three month average employment gain has been solid recently.
The strength in the US economy no doubt removes any chance of additional QE in the foreseeable future, therefore, talk of gold challenging its all-time highs any time soon is premature. However, the street expects the Fed to begin tapering in September, which is now little over a month away. Should we get another soft employment print before then, there will be pressure on the Fed to delay tapering, at least for a month or two, to ensure that the data is not turning.
Gaining 150k of jobs each month is still good progress, and 7.4% unemployment is much better than it has been; but 7.4% is still a high unemployment rate, and therefore, the Fed will be biased to urge on the side of caution when pulling back on their QE programs. The recovery is still fragile, and there is a significant risk that the Fed moves to remove monetary stimulus too soon, whereas there is very little downside in waiting another month or two before tapering.
However, should the Fed postpone tapering in September, the market will overreact and view this as a dovish move from the Fed. For the gold market, some traders may incorrectly presume that this means tapering is off the table, QE is back on and gold prices are going back to their old highs. The buying of gold that a delay in tapering could spark would cause a minor rally, which could gain steam given that we are approaching a seasonally strong time for the yellow metal.
The period from September to January has been the time when gold has performed the best over the last decade. Granted, the last decade was a bull market which we are arguably no longer in, but even so, we feel this could be a driver of a relief rally in gold - even if all it does is increase bullish sentiment.
Technically speaking, the $1350 resistance level held for gold this week, and we would not expect gold prices to rise up through that level unless tapering was delayed or US economic data took a turn for the worse.
We would also note that the MACD appears ready to make a bearish crossover, and the RSI is weakening with room to fall down to the 30 level. Gold is still in a downtrend, with lower highs, ($1650, $1600, $1480, $1350) and lower lows ($1550, $1350, $1200).
If we had to put some rough probabilities on the next moves in gold, we would say there is at 90% chance that the next $300 move in gold is down, but only a 65% chance that the next $100 move is down. Given our estimate of a one in three chance that gold can rally $100 from here, patience is the order of the day. Rallies in gold should be gradually faded, but short positions should not be taken with too much aggression. We still prefer a core short position on gold, as the chances of gold going below $1000 in the next six months are better than 50-50.
We are closing our subscriber service to new customers this week due to an excess of demand, but we are keeping our positions nimble and preparing to carefully manage our risk over the next month. Risk-reward dynamics are our main focus with every trade we make; this approach has generated a 727% increase in our model portfolio since inception, and we are simply pointing out that at this stage, the risk-reward dynamics are still in favor of being short gold - but they are not as strong as they have been previously this year. As such, our short positions are not as aggressive as they have been.
However, if US data remains strong, and the Fed push ahead with tapering, then gold prices are only going south. Shorting gold at any level above $1000 is a good trade in that scenario. However, under any scenario, we still do not see the value in buying gold mining stocks. All will fail to deliver on the massive investor expectations that have been built up over a decade of constantly rising gold prices. Many will struggle to meet even the reduced expectations, and we have no doubt some will be forced out of business completely.
Do not be fooled by the recent dead cat bounce in gold stocks; the chart below shows the true picture.
The relief rally has run out of steam above 250 on the HUI, and it is our view that we will see 150 before 350. Therefore, we would not be holding any gold stocks whatsoever, and even though we are not holding any short positions on this sector currently, we are looking at shorting a select few miners that we feel are particularly vulnerable.
In conclusion, we are still bearish on gold, but concede there is a risk of a rally back in the latter part of 2013. Therefore, whilst we maintain a core short position on gold, this position is not as aggressive as trades we have held previously this year when then risk-reward dynamics were more in favor of being short gold and we acted aggressively, banking triple digit returns using put options. We will be monitoring the situation closely over the coming weeks and adjusting our model portfolio accordingly. Best of the luck out there.