Important Lessons From The Trump-Inspired Breakdown For Gold

| About: SPDR Gold (GLD)
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Summary

The election of Donald Trump as the next President of the United States was accompanied by a major technical breakdown in gold.

While gold looks resilient in the face of two rate hikes in 12 months, the overall context suggests the path of least resistance remains down for the short-term.

I examine a confluence of fundamental, technical, and sentiment driven factors to derive important lessons for trading gold going forward.

These factors include rate expectations, trading in the U.S. dollar, Google Trends, the Indian rupee, speculative positioning in futures, and technicals for SPDR Gold Shares (GLD).

The SPDR Gold Shares (NYSEARCA:GLD) has increased 6.3% since December 15, 2015. The U.S. Federal Reserve hiked its interest rate the next day and made its second hike for this cycle two weeks ago. This gain against the rate hike grain SHOULD be the headline for GLD and a relatively positive one for gold's resilience going forward (there is an enduring fear that the start of a Fed tightening cycle signals the beginning of the end of an economic recovery - such fear seemed to play out as GLD soared in the first half of 2016). Instead, the main headline for now is that GLD collapsed mightily from a 28-month high set over the summer. The election of Donald Trump as the next President of the United States confirmed the top from a technical standpoint given a double-whammy of a confirmation of resistance at the 50-day moving average (DMA) followed immediately by a 200DMA breakdown. The bulk of GLD's decline from the highs have come from the 11.3% post-election plunge.

SPDR Gold Shares is up 6.4% for the year but down 17.1% from its 28-month high. Confirmed resistance at the 50DMA and a 200DMA breakdown confirmed a topping pattern.

Source: FreeStockCharts.com

The writing was on the wall for GLD starting with the summer high, but I first focused on finding a spot for playing a bounce in the middle of the sell-off. When I wrote in early October about a potential bottom for GLD, I speculated that any subsequent rally would fail to top the 28-month high. The bottom worked out for a month as GLD followed along its 200DMA uptrend. The post-Trump sell-off made sure that meager rally would not even come close to challenging the last high. The pullback in speculative positioning on gold futures contracts that I saw as an opening for upside has transformed into its own confirmation of a top in gold. Speculators have pulled back consistently ever since the 28-month high in GLD; the correlation with gold prices is now unmistakable.

Speculator positioning has dropped consistently from the summer highs and now sits at levels last seen in February.

Source: CFTC's Commitments of Traders

The chart above suggests that gold will not regain former momentum until speculators get back on board.

In the meantime, the prospects for the next Fed rate hike are murky. The market's Paul Reveres ran through Wall Street warning of three rate hikes in 2017 instead of the previous market consensus around two hikes in 2017. As I noted two weeks ago, I did not interpret this situation as hawkish. For example, the 30-day Fed Fund Futures market is pricing in the next Fed hike all the way out in June, 2017. If this scenario plays out, I do not expect the Fed to get bold enough to subsequently roll out two more quick rate hikes before the end of 2017.

The market does not expect the Fed rate hike until June, 2017. The market is even starting to waver on how soon to expect that hike.

Source: CME Group FedWatch

Regardless, a LOT can and will happen in the next six months; yet, the market's moves in the past two weeks imply a high level of certainty for what is coming in this time. The biggest wildcard out there sits with President-elect Trump's actual policies. Current posturing suggests a highly inflationary fiscal policy, and the market has assumed the Fed is prepared to act swiftly in concert with such inflation-priming. I am of the mind to wait-and-see whether either side of this deal actually deliver. In the meantime, I will follow the market…a market which sent the U.S. dollar index (NYSEARCA:UUP) breaking out to a new 14-year high in the wake of the Fed meeting.

The U.S. dollar index (DXY0) broke out to a new 14-year high in reaction to the Fed's rate hike and statements on monetary policy.

Source: FreeStockCharts.com

The lofty heights of the U.S. dollar further undermine gold's ability to rally.

As one last signal, I checked in on Google Trends. As a reminder, I use Google Trends as a proxy for market sentiment on gold when GLD reaches some kind of trading extreme. In this case, the extreme was the sharp surge and then plunge in the wake of the U.S. Presidential election that confirmed bearish technicals for GLD. I use the simple search phrase "buy gold" as two separate words to measure the trend. If sentiment spikes in parallel with the extreme trading, I assume that a reversal in GLD is imminent - whether to form a top or a bottom.

In recent posts on GLD, I noted the challenge of "term pollution" from searches using "buy gold" that do not refer to the precious metal. I am now actively tweaking my methodology to accommodate this pollution. I may have stumbled upon a satisfactory substitute with topics in Google Trends. The charts below show the trends in the topic "gold as an investment."

On the day after the U.S. Presidential election (Wednesday, Nov 9th), interest in gold as an investment experienced a significant spike.

The spike in investment interest was also significant relative to previous spikes in interest, including Brexit in late June.

Source: Google Trends

The latest spike in interest in gold as an investment corresponds directly with the fallout from the election of Donald Trump. However, interestingly, the top 5 regions for this trend over the past 5 years are all outside the U.S. and four of five are in the Middle East. When I shorten the window to the past 90-days the main change is that Kuwait replaces Bahrain as #5. The United States ranks as #18 in both lists. The top related queries are also dominated by the Middle East - specifically the Kingdom of Saudi Arabia (NYSEARCA:KSA) and the Saudi Arabian riyal (NYSE:SAR) - but the Indian rupee features prominently. When I further constrain the window to November 8th to 10th, the United States finally ranks in the top 5, but India sits by far as the #1 region and dominates related queries. In other words, the Indian government's shock announcement on November 9th that overnight it cancelled 500 and 1000 rupee notes presents a confounding factor influencing gold's price. If anything, the interest in gold related to the rupee's manipulation has likely prevented gold from falling further faster that it already has. I am assuming that holders of Indian rupees are looking to gold as a potential alternative to shield themselves from further government machinations with the currency.

This mix of signals means that I have to measure carefully the sentiment spike relative to the context. If the U.S. Presidential election had not occurred and driven the U.S. dollar to a 14-year breakout, I would have confidently assumed that gold had finally reached another (tradeable) bottom. Instead, the larger context forces a more nuanced interpretation of the sentiment signal. I am left with making a much softer and more conservative conclusion: the spike in gold sentiment confirms that something significant has occurred in the trading of gold. Given the context, fundamental and technical, the sentiment spike confirms that gold has likely topped out for the time-being. In other words, given a spike in interest was unable to turn the tide, I am assuming the path of least resistance will firmly remain downward. GLD's low from 2015 is back in play.

A look back at the last major spike in interest in gold further supports the need for me to make this adjustment in my interpretation of the sentiment signal. During that time, April, 2013, the S&P 500 (NYSEARCA:SPY) experienced a sudden and sharp one-day sell-off that ended an extended rally. The volatility index (VIX) soared and gold fell 8.7% for its largest one-day loss in 33 years. Before the drop, I claimed that a bottom in gold would prove elusive partially given a continued slide in GLD without any sign of interest in sentiment through Google Trends. The plunge in GLD was accompanied by soaring sentiment (as seen in the charts above), and I eagerly pronounced a likely bottom in gold. Gold did experience a two-week relief rally and a 2-week period of stabilization. Alas, the sell-off resumed from there, and GLD has yet to come close to those levels again since.

On the surface, the April, 2013 episode revealed a weakness in the usefulness of the contrary nature of the sentiment signal. However, the important context I dismissed too easily during that episode was that GLD suffered a major technical breakdown. Like any technical breakdown, a reversal requires confirmation. In April, 2013 the relief rally fell short. GLD reversed the second gap down but resumed its weakness shortly thereafter. At that point, I should have noted the end of the contrary sentiment signal. Moreover, GLD broke down again in June - a move that then invalidated the presumed bottoming signal from sentiment. Overall, that episode for GLD served as a reminder of my experience with major technical breakdowns: they tend to generate follow-through before a complete reversal and end to the breakdown.

SPDR Gold Shares had a very rough 2013 - a brutal sell-off from which it has yet to recover.

Source: StockCharts.com

Going forward, I plan to continue refining the use and application of the gold sentiment indicator. I will be particularly careful to marry sentiment with technicals with a close account of the headline fundamentals. In the meantime, my trading strategy has returned to sitting pat on my core long-term position in GLD. I am waiting for the next bullish signal before daring to trade around that position again. Given current momentum, I am assuming that next check-in will occur as GLD nears 100 and 2015's low.

{Note that I interchangeably refer to gold and GLD given their on-going and persistently tight correlation}

Be careful out there!

Disclosure: I am/we are long GLD.

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: In forex, I have mixed positions with the U.S. dollar