Last week was a red letter week for those positioned in precious metals. For what felt like the first time in a lifetime both metals put in performances that busted through technically significant overhead resistance. Both gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV) put in weekly closes that will bring momentum players back onto the long side of the market as opposed to endlessly selling rallies. The impetus for this rally was not only the TIC report, which I talked about in my previous article, but also the growing realization that while the Fed may want to taper its bond purchases under QEIII/IV it is clear the market wants nothing to do with that course of action and sold US Treasuries without prejudice.
The close on the benchmark 10-year bond (NYSEARCA:IEF) above 2.8%, and following through on the open this week to touch 2.9%, is a strong signal that the Fed either cannot or will not contain the selling, depending on your point of view. The 2.75% level on the 10-year bond had held for the past seven weeks.
Closing prices have power and weekly closes which throw reversal or breakout signals have a lot of near-term power. The weak close in US Treasuries wasn't the only weekly close that was so important. The close in Gold was also very strong.
While this move above $1350 in Gold doesn't do much to offset the huge washout in price we've seen in 2013, it does represent anomalous behavior in a market that has not been able to even challenge the bottom of the previous short-term trading range since the Bundesbank demanded its gold back from the Fed's custodianship in mid-January. Moreover, look at the chart closely and last week was the first time gold has been able to break above a level that had served as multiple week resistance all year.
Something has definitely changed in the gold market for the better if you're a bull. Last week's close was a follow-through of the weekly reversal signal given during the week of July 21st. At this point, however, gold will have to still best the June high at $1423.60 to have put in a reversal signal on the monthly chart. Until that happens while gold may have bottomed here, the new uptrend may still take a few months to emerge.
Now, as constructive as the situation is in gold, the situation in silver is better.
Silver is flirting right now with a two-bar reversal signal on the monthly chart. A close in August above $22.98, the June high price, would be a strong signal for the beginning of the next leg of the bull market to have resumed.
A number of things have come together to put buying pressure under the precious metals now.
- Increased volatility in emerging market currencies like the Singapore dollar (NYSE:FXSG), Mexican Peso and Malaysian Ringgit which will continue to put pressure on US interest rates through net selling of US Treasuries.
- Strong indications from Europe that the very worst is over and capital will continue flowing back across the Atlantic as evidenced by low Italian and Spanish bond yields and a Euro (NYSEARCA:FXE) pushing back up towards $1.34.
- The equity markets putting in topping action, with the S&P 500 (NYSEARCA:SPY) opening up this week to continue the current short-term downtrend.
- Violence in Syria and especially Egypt putting a very strong bid underneath oil prices. Brent Crude (NYSEARCA:BNO) closed at $110.70 per barrel last week, a breakout from a six week consolidation between $105.75 and $110.08.
With the Jackson Hole meeting of the Fed governors happening this week, all eyes are on what the presumed new leadership will do with respect to the taper. Even if the Fed decides to go through tapering back on bond purchases, which will send rates higher but will also create a lot of knee-jerk dollar buying, the Fed will not be able to stop producing credit without the US economy, already at stall speed from a GDP perspective, from imploding.
If the budget deficit in July was $98 billion and the bid-to-cover ratio of US bond auctions is falling, how is the Fed going to go about this tapering? They could redefine QE and begin outright monetizing other instruments, and force the primary dealers to hold onto the bonds without repo-ing them immediately, I suppose.
For that reason, I believe that it's extremely important to look at the total Fed credit created numbers on a weekly basis as a proxy for how it is conducting QE since total bank credit has been flat since the announcement of QE IV back in December.
The above chart holds the key to the future of the Fed's actions here. The black bars are the weekly change in total Fed credit while the blue ones are the totals for each month. Each month consists of a four (or five)-week pattern in which the Fed creates new credit, rising for the first three weeks and then falling off in the last week of each month. Note that in the first two weeks of August - red bars -- the Fed has created more credit each week than it has in corresponding weeks in every previous month since it began QEIII/IV, or $41.3 billion so far.
If the pattern holds true, then the Fed will most likely create more than $60 billion in fresh credit this week. With yields spiking, however, it may be withholding bond purchases -- the taper -- and we'll see a vastly lower amount than that. Of course, if the number comes in at $60 billion and yields are still spiking, then the net selling in the bond market is really intense and the Fed is simply acting like the Little Dutch Boy trying to hold things together.
That will be the key to parsing whatever statement comes out of Jackson Hole. This is the "put up or shut up" chart for the Fed's communications program and the key to what is coming next for the precious metals market. If the pattern holds and all of this taper-talk has been just that, talk, then gold and silver will continue to advance. If it is broken, then the Fed is serious about tapering, then gold and silver will pause and set up a longer-term bottoming pattern defined by the June low and high for gold and the June low and August high for silver.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I own physical gold, silver a few dairy goats and a cream separator. You do the math.