Why Is Gold Rising After China's Rate Hike?

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Includes: DBC, FXI, GLD, REMX
by: Jeb Handwerger

On Christmas Day, the Chinese central banks raised interest rates for the second time since October. Surprisingly, commodities soared on the rate hike news. This tightening policy should be bearish for commodities; however, gold, silver and the noble and base metals have been soaring. An up move on a negative news day is very bullish for gold. Precious metals are once again beginning their move.

I expected a rate hike at the Central Bank's last meeting on December 13, and I wrote that the pause was due to the holiday season and to wait until after the holidays for an increase. Obviously, their decision to surprise the markets on Christmas Day demonstrates how urgent it was to curb irrational speculation, rising prices, and commodity costs. A growing middle class is finding it harder to survive as wages are stagnant, yet basic costs are soaring. The Chinese also cut rare-earth exports, which is causing a major increase in these mining shares. In 2011, I expect them to keep looking for natural resources abroad to further fuel their growth and demand. This last rate hike was looked upon by the markets as weak, and commodities have skyrocketed since the announcement.

One of the most interesting realizations I have gained from studying the financial markets is that success comes from developing a clear set of rules and sticking to them despite the current psychology and tenor of the market. Contrary to popular opinion, being successful in the market is not based on how smart you are or what university you attended; success is about sticking to your discipline and following a methodology.

One person who has greatly influenced me is Jesse Livermore. Livermore was very poor growing up and didn’t have a formal education like most of the fund managers today. He was extremely disciplined and he developed a rules-based methodology, which made him one of the most successful traders of his time. One of his famous teachings is: The smarter you are, the easier it is for the market to fool you. Many times the market does the exact opposite of what economists and pundits predict. Livermore found a simple method to follow a trend and monitor price volume, which helped him surpass the top traders of the time. However, Jesse Livermore ultimately committed suicide, and in the note he left behind, he stated that he considered himself a failure for not sticking to his own rules.

The recent subprime debacle and the 2008 market crash shows that the smartest academicians had absolutely no grasp of the dire situation that was at hand and continued to recommend the “buy and hold” doctrine. The Federal Reserve itself wasn't admitting we were in a recession until many investors suffered a major loss. Meanwhile, behind the scenes, institutional investors were trading the volatility and making huge profits on the short side as technicals gave clear sell signals and shorting opportunities during the downtrend. The professional traders and institutions don’t subscribe to the “buy and hold” methodology even though they market it to the ill-informed public. Institutions and hedge funds go long and short and move to cash when conditions warrant it.

Using a basic set of technical rules and reviewing market tops, a technical trader is able to prevent a major loss and wait for less-risky opportunities to capitalize and increase gains.

Since October, the Gold ETF (NYSEARCA:GLD) had three failures at upper resistance and has not been able to make a major move into new highs. In early October, I warned of a major rally in the dollar and a rise in interest rates much to the dismay of market “experts” who were expecting QE2 to devalue the dollar and keep bond prices high. The exact opposite occurred. Bond prices plummeted, the US dollar rallied, and gold has been range-bound. My mining recommendations in precious metals, uraniums, molybdenum, and rare earths have significantly outperformed.

click to enlarge
Click to enlarge

Again, the market goes against logic. China’s rate hike should have been bearish on the price of gold, but instead, commodities are soaring. Gold has bounced off the 50-day moving average and has found support, which is a very positive sign. This second test of the 50-day and the bounce after the raising of rates by China may signal that the three-month consolidation is over and that gold has finally found enough support to make the next leg into new highs. Investors are shrugging off the rate-hike news and moving back into commodities with full force. Technically, this is very bullish, and I am looking for a strong move into new highs. The next leg may be beginning, providing a better market entry point than in early October. New signals have been alerted.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.