How To Trade Gold Now?

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Includes: DGL, DGLD, DGP, DGZ, DZZ, GEUR, GHE, GHS, GLD, GLDI, GLDW, GLL, GTU, GYEN, IAU, OUNZ, PHYS, QGLDX, SGOL, UBG, UGL, UGLD
by: Macrotheme Capital Management LLC

Summary

Gold fundamentals have been improving lately.

Technically, gold has possibly started the new longer-term uptrend.

However, the long gold trade is still an early momentum trade.

The higher probability trend following trade in gold needs to see the $1,520 level break-out.

There has been lots of excitement about gold (NYSEARCA:GLD) lately, especially after the price of gold breached the $1,300 level. Could this be the beginning of the new longer-term uptrend in gold? Obviously, if yes, then this is an opportunity to trend-follow gold higher.

Let's first discuss the fundamentals:

Over the last 12 months, gold has been almost perfectly negatively correlated with the yields on 10Y Treasury bonds (NYSEARCA:TLT). Here is the chart - gold ETF (GLD) is the blue line:

So, gold has been rising as the interest rates have been falling. Why? As I have previously explained, gold is likely to soar with the first signs of the next recession. So, falling interest rates likely point to a slower economic growth, and eventually a recession.

But what is the chance of recession right now? One of the most reliable leading recession indicators has been the yield curve spread, or the difference between the 10Y TBond yields and 2Y TNote yields. Specifically, all recent recessions have been preceded with the inverted yield curve. Here is the chart:

So, the yield curve spread has been flattening, as the 10Y TBond yields have been declining. However, the yield curve spread is still positive. Thus, the next recession is unlikely to happen any time soon, at least as suggested by the yield curve indicator.

There are other fundamental variables that we could discuss, such as the geopolitical situation with North Korea and the US debt ceiling debate. These variables could provide support to gold, but at this point, the market is not suggesting that any of these other variables are likely to cause the US recession.

Fundamentally, my generally positive outlook on gold is based on the following scenario: the next recession arrives while the short-term interest rates are still very low, and thus, the Fed is forced to ease below the zero bounce - to negative interest rates. The probability of this scenario is rising. However, it's still very low. Nevertheless, the direction of long-term interest rates and the direction of the yield curve spread are both bullish for the gold.

Let's discuss the technical picture:

I use very basic technical analysis to determine the price trend, just to make sure I don't trade against the trend.

So, what is the trend in gold right now? Here is the chart:

Gold has potentially started the new longer-term uptrend in January of 2016. However, this trend must be validated. Here are the three key points:

  • Point 1: Gold has to hold the January 2016 low near the $1,050 level. If this support is broken, the downtrend continues. As long as this support holds, we could still be in a bottoming process or in the new uptrend. For gold ETF (GLD) this is the 100 level.
  • Point 2: It is important that gold makes the new high above the $1,370 level, which would confirm the new uptrend since January 2016. The resistance to this move is near the $1,450 level. For gold ETF (GLD), these levels are $130 and $140, respectively.
  • Point 3: The major break-out point for gold will be near the $1,520 level, which is the previous breakdown level that confirmed the change in trend in 2015. Thus, technically, the new longer-term uptrend in gold will be validated when gold breaks the $1,520 level. For gold ETF (GLD), this is the $150 level.

Note, this is a very simple analysis of key turning points in price of gold, as well as the key support/resistance levels.

So, how to trade gold now?

In summary, gold fundamentals have been improving lately, given the falling long-term interest rates, and narrowing yield curve spread. Technically, gold is possibly starting the new longer-term uptrend. However, the new uptrend must be verified. Similarly, the yield curve has to continue to flatten towards the zero level to support further gains in gold.

Thus, at this point, the long position in gold can be possibly described as an early momentum trade, which can be profitable but also vulnerable to violent reversal. Higher probability momentum trade will likely happen as gold breaches the $1,520 level, especially if the recession probability significantly increases.

I will follow this and update.

Disclosure: I am/we are long GOLD FUTURES.

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.