Gold Suddenly Looks Toppy

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Includes: DBC, GLD, GTU, IAU, JJCTF, OUNZ, PHYS, QGLDX, SGOL, SLV, SPY
by: DoctoRx

Summary

I've been tracking gold both out of interest in the asset itself and for its implications for other major parameters such as interest rates.

Having recently opined neutrally that gold might be at a crossroads, oil's recent price drop and growing hawkishness among central bankers may have set gold on a lower path.

This article updates these and other influences on gold's allure to the investing public and concludes cautiously that this looks like a tough time to go long the metal.

Introduction

Despite all the money created in the aftermath of the Lehman fiasco and general banking insolvencies, something is fishy about gold. During the post-2011 period when gold began trending down, especially 2013 when QE 3 "should" have led to a high price of gold, the standard response by bulls on gold (NYSEARCA:GLD) was to look at the occasional severe bear market gold suffered in the 1970s despite heading from a free market price of gold around $44/ounce in 1971 to over $800 in early 1980.

But, whatever happens to gold going forward, this is going on far too long for that analogy to hold.

As a former gold bull as a blogger in 2009-11, and as someone whose first two articles for Seeking Alpha in Q1 2013 were bullish ones on gold and oil, I began seeing the weakness in gold soon thereafter, dropped the inflationary bias from my investing and my articles, and moved on. Subsequently, I turned bearish on gold from at least a trading perspective last summer even though it was at a much lower price than in early 2013 when I was bullish; that's markets for you. That Sept. 9 article, Gold Overvalued By Many Metrics: A Balanced Analysis, was written with GLD at $127.24; it's around $115 as I write this. I followed that post-election, when many were expecting a Trump administration to pursue inflationary policies that would lead to a higher gold price, with another bearish one, Why Gold Can Crack $1,000, Then Challenge $700; gold is down about 4% from its opening price of that day, Nov. 11. A crux of that argument, updated below, was that oil prices might drop a lot as a "Reagan 2.0" strategy of unfettering US oil production could drive oil prices and also inflation rates down a good deal; another point, discussed in more detail in the following section, was that central banks may have printed all they were going to print for some time to come. If so, the inflationary aspects of that money-printing may have already been maximally felt, while the disinflationary/deflationary effects of aging populations in the world's richest countries and other factors might come to the fore.

As we know, gold prices went lower since then, but the longer oil prices held well above $50/barrel and inflation data perked up in the US and EU, the more I turned neutral on gold. In the midst of earnings season, I did not get a chance to write about gold until recently, at which point I felt that for technical and fundamental reasons, something might pop in either direction for both gold and oil. Thus, I wrote Gold, Oil At The Crossroads: Analysis on March 3.

Lo and behold, oil soon cracked lower, and gold has begun to enter a minor downtrend, perhaps in sympathy. Maybe that article was timed luckily. Because of that possibility and the breaking news discussed below, this article is written to update my views of gold's prospects as of March 13, and to solicit yours if you wish to provide them in the comments section.

Are central bankers normalizing policy?

An outbreak of conventional financial behavior may be sweeping the major central banks.

First among equals there's the Fed, which is hawkish now.

Then there are some less dovish signals from Mario Draghi, head of the European Central Bank.

Now, we have this from Bloomberg News Sunday:

The Bank of Japan's bond-purchase plan for March puts policy makers on track to miss an annual target, leaving investors debating whether they're witnessing a stealth tapering.

Calculations based on the plan released Feb. 28 suggest a net 66 trillion yen ($572 billion) of purchases if the March pace were to be sustained over the following 11 months. That's 18 percent less than the official target of expanding holdings by 80 trillion yen a year...

The expected pick-up in inflation [in Japan] and rising U.S. Treasury yields have put pressure on the BOJ's yield-curve control policy.

At a certain point, central banks are political constructs and cannot anger voters too long. There are a lot more savers than there are bankers who love cheap central bank money. In addition, after years of massive money printing far in excess of the economy's ability to put the money to work ("QE"), returning to a conventional policy of minimal excess reserves would likely be a central bank's preferred economic course. This would fight inflation and be adverse to the fundamental case for gold.

That's the first problem for gold bulls.

Oil trends a problem for the inflationary scenario

The second is the ongoing deterioration in both oil prices across the multi-year time frame in which crude oil is traded along with worsening sentiment. Crude oil and gold prices have traded together directionally since President Nixon delinked the USD from gold in 1971.

Bloomberg again from Sunday, as West Texas Intermediate crude oil traded down to about $48/barrel as of 9 PM:

Oil Extends Decline as U.S. Drilling Accelerates Amid OPEC Cuts

...Oil last week broke below the $50 a barrel level it had held above since the Organization of Petroleum Exporting Countries and 11 other nations started trimming supply on Jan. 1. U.S. crude stockpiles have climbed to a record and production surged to the highest in more than a year, while Saudi Arabia's Oil Minister Khalid Al-Falih said global supplies are falling slower than expected.

"Supply appears to be outpacing demand, putting the focus back on the glut," said Jonathan Barratt, chief investment officer at Ayers Alliance Securities in Sydney. "OPEC is unlikely to react until prices get down to about $40 a barrel."

Talk that frackers have brought their breakeven production price point down near $40/barrel is all over the mainstream press now. This is great for consumers and oil-importing countries, and bad for gold.

Worse for gold, the oil price curve tracked by the CME futures exchange is a mess. The price is down, and it's down going out to December 2025. What I'm looking at as of 9:30 PM shows WTI crude at $50.05 for December 2018 and December 2019 delivery. December 2020 is only at $50.24. As of Friday's close, December 2025 crude is down to $54.51.

So what this downtrend up and down the time frame out to 2025 is clearly showing is that traders are not just seeing short-term oversupply issues; they are seeing deflationary energy abundance at current price levels.

Oil price deteriorates despite huge bullish speculative sentiment

Worse, the oil market has continued to show record amounts of speculative bullishness even as prices have acted horribly. Here, in FINVIZ charts, the green line shows the net position of commercial hedgers. The farther below zero it is, the more the speculators ("specs, both red and blue lines) are collectively bullish by number of contracts. The continued bullishness of the specs despite suffering loss after loss since oil peaked post-recession in 2011 astonishes me. Here's the weekly chart:

Note: For more detail, click on the "D" tab on the upper right of the webpage for the daily chart.

What this shows is that spec bullishness has been running extremely high, near record on an absolute contract count basis. When oil bounced up in Q1 2016, you can see that the green line was negative but near zero, reflecting spec caution. Now we see the same sort of downsloping price trend in the near months that we also saw both in mid-2014 as the bear market was getting underway, again in Q2 2015, and once again in Q3-Q4 2015. No guarantees on any chart pattern repeating, of course; but given the immense spec bullishness, this looks like a risky situation for oil bulls.

The relationship of gold and oil prices to each other may or may not continue forever. I, however, tend to think that it's been so well entrenched that it is reasonable to consider it. And if it merely goes back to 20X, namely the ratio of an ounce of gold to a barrel of crude, then crude at $50 would imply gold at $1,000. Crude at $40 would imply gold at $800.

That's significant downside risk with no guarantee of upside later.

How long before gold investors begin to wonder if the increasing automation of manufacturing processes produces "good deflation," rendering deflation protection in the form of aggressive pursuit of secure income as or more important to the mainstream as inflation protection became in 2001-2 after President Bush advised Americans to shop till they dropped, thus reproducing his version of LBJ's guns and butter policy; followed by QE?

No answers, but it's getting tougher to see putting new money into gold here - except as general insurance. But this article is directed toward gold in its various forms as a trade, not a permanent sort of hedge against disaster.

Gold also has that bullish spec sentiment - will it crack?

Despite oil breaking lower last week and gold's rally faltering, traders on the futures market in the US remains bullish - though not maximally so. From FINVIZ, the weekly gold chart:

Except for the first period after gold's 2011 peak, gold has had to see the large traders go flat (red line to zero) before it bounced upward. Understanding that the above data are not daily and could already have changed a good deal, this adds to the spreading technical weakness of gold and GLD on several time frames. Both the daily and weekly charts of GLD show it to be in poor technical condition; only the monthly chart is OK, with GLD holding above its 150-month (12.5 years) exponential moving average. GLD, which embodies expenses that many owners of significant amounts of physical gold also incur, is now back to a price it first reached in November 2009 - which I would have thought was a highly unlikely event absent another deflationary recession/depression when I was buying gold, silver and other inflation hedges by the boatload in 2010 and Q1 2011 as QE raged.

Yet here we are. The bulls certainly have a good fundamental case: look at all the quantity of money. Look where the stock market (NYSEARCA:SPY) is. Won't gold just do what it always has done in the past, and reflect all that money printing? After all, the old definition of inflation was quantity of money, not the change in the general price level (whatever that exactly is).

Let's read the tea leaves a bit to get to a conclusion.

Some other portents for gold

It's not just oil. Copper, for example, which has an exchange-traded note proxy (JJC), has begun to make a bullish-to-bearish chart flip. So has the lightly-traded commodity lumber:

For what it may be worth, the sentiment pattern on lumber, with the large traders (red line) now as bullish as they tend to ever get, has routinely correlated with upcoming price declines. So that's a negative; the weekly more comprehensive lumber and panel market report from Random Lengths is much more constructive, though short term also heading down.

Very broadly, I track several commodities funds that trade on the US stock exchanges. I believe that all suffer from the "roll" effect that brings prices down steadily given that commodities tend to be in contango. That said, here's a possible renewed rollover pattern from the broad PowerShares DB Commodity Index Tracking ETF (NYSE:DBC), which is not overweighted to oil as some other commodity tracking funds are:

DBC Chart

So, it's not only oil; there is some weakness that one might not expand from an expanding economy that's going to be boosted further by an irresponsible Congress and White House.

Another straw in the wind is the duration of the current economic expansion in the US. The Fed is engaged in a rate-raising program despite nominal GDP growth over the past year of only 3.5%. This is a level often seen in recessionary periods. And in echoes of the deflationary Great Recession, Bloomberg is out over just the past few days with two different articles suggesting bursting bubbles. One is titled, U.S. Subprime Auto Loan Losses Reach Highest Level Since the Financial Crisis. The other, the title of which I like less as it's too close to what was going on as the Great Recession was unfolding, is Wall Street Has Found Its Next Big Short in U.S. Credit Market.

This article explains:

Like the run-up to the housing debacle, a small but growing group of firms are positioning to profit from a collapse that could spur a wave of defaults. Their target: securities backed not by subprime mortgages, but by loans taken out by beleaguered mall and shopping center operators. With bad news piling up for anchor chains like Macy's and J.C. Penney, bearish bets against commercial mortgage-backed securities are growing.

In recent weeks, firms such as Alder Hill Management - an outfit started by protégés of hedge-fund billionaire David Tepper - have ramped up wagers against the bonds, which have held up far better than the shares of beaten-down retailers. By one measure, short positions on two of the riskiest slices of CMBS surged to $5.3 billion last month - a 50 percent jump from a year ago.

And:

Cracks have started to appear. Prices on the BBB- pool of CMBS have slumped from roughly 96 cents on the dollar in late January to 87.08 cents last week, index data compiled by Markit show.

That's still far too high, according to Alder Hill [a short seller].

If the Fed tightens repeatedly this year, I'd expect more strains on challenged borrowers, and I'd also expect the heavily bullish margin debt that's helping to prop up the SPY to decline. All of these factors are gold-bearish right now.

At the same time, most people are feeling better, with the Bloomberg Consumer Comfort Index, which Econoday reports weekly, last week showing its best reading in quite some time:

Released On 3/9/2017 9:45:00 AM For wk3/5, 2017

Prior Actual
Level 49.8 50.6

Highlights
The consumer comfort index continues to build to new cycle highs, up 8 tenths in the March 5 week to 50.6. Strong gains in many confidence readings, however, have to result in strong gains for consumer spending.

I believe that this is the first reading above the negative level (50 is neutral) since the Great Recession.

So, paradoxically, just as was the case somewhat before or in the early stages of the last recession, much of the public is feeling better, which takes away demand for gold as a crisis hedge; and on the other hand, deflationary pressures are brewing in overleveraged borrower-land. So gold might get the worst of both trends for a while.

Conclusions

My own humble opinion is that this is one of the trickiest late-cycle periods for traders. The article is not assessing gold as a permanent hedge or asset for insurance against disaster, very high inflation, etc., but instead as a tradeable asset as a stock or ETF might be.

Based on that premise, it's difficult for me to now see gold in its various physical or fund forms, or using a gold mining stock or fund as a proxy, as being attractive. The Fed for sure, and increasingly more central banks, are signaling that they have printed enough, or more than enough money. This is being done while in the US, wage gains are small and a huge reservoir of untapped labor has been sidelined by an underperforming economy.

My thought is not to fight the Fed here. And, not to fight the trends in oil and to a lesser degree in gold itself. If the quantity of money principle is going to work, it will show itself; and the gold market is so vast that the charts should turn bullish long before gold gets to where it "should" trade based on the Fed's balance sheet or total federal debt. Thus, new money investments I'm making are still holding off from a commitment to gold, oil, silver (NYSEARCA:SLV), and the like. When these important assets will change, or whether the bottom happens to be in right now, is important to most investors and something interesting and worthwhile to track and, where possible, profit from.

Thanks for reading; all comments are welcome.

Disclosure: I/we 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: Not investment advice. I am not an investment adviser.