Gold Market - Corrections Or Consolidation Phases Are Good

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Includes: GLD, IAU, SLV
by: Simple Digressions
Summary

After breaking above their strong resistance at $1,300 per ounce, gold prices are heading for another cyclical resistance at $1,375 per ounce.

However, the buying pressure demonstrated by money managers, big speculators trading gold futures, is dissipating now.

What's more, there is a big medium-term divergence between gold prices expressed in U.S. dollars and euros.

In my opinion, we are ahead of a correction/consolidation phase in gold, but I am not worried.

Corrections and consolidation phases are typical for healthy bull markets and can say a lot about the character of the ongoing move.

The current rally in gold prices has been very impressive. After breaking above their strong resistance at $1,300 per ounce, gold prices got very close to another resistance (look at the red circle on the chart below) -- this time at $1,375 per ounce. As a rule, each bull market is defined as a sequence of higher tops and higher bottoms. Therefore, if gold is in its bull stage, we should see gold prices breaking above the last top soon (established in summer of 2016 at around $1,375 per ounce):

Source: Simple Digressions

However, it looks like now gold is closer to a correction/consolidation phase than to crossing a pivotal point at $1,375 per ounce.

COT report

According to the Commitments of Traders report (COT report), a buying pressure reported by money managers is dissipating:

Source: Simple Digressions

The table shows changes in gross and net positions held by money managers. Note that between July 18 and Aug. 8, 2017, the upward trend in gold prices was fueled by short sellers cutting their short positions (the panel on the left). Then, between Aug. 15 and Aug. 29 the prices of gold were driven by new traders entering the market and adding fresh long positions (the panel in the middle).

Last week (the row marked in grey) money managers added "only" 16.4 thousand new long positions, and, for the first time since July 11, 2017, increased a number of short positions as well (by 0.4 thousand contracts). The net long position went up by 16.1 thousand contracts, which was the lowest increase since July 25.

In my opinion, the easing buying pressure may be an indication of an incoming correction in gold prices -- and I am not worried. During a healthy bull market the corrections or periods of consolidation are common. In other words, the faster gold prices go up the more volatile the market becomes. That's why I would like to see some consolidation before gold prices go further up.

Another point is that traders should closely monitor the gold market now. Simply put, it is crucial from a longer-term perspective to see the way gold prices behave above their strong support at $1,300 per ounce. If they hold above this support, I am an optimist. However, if they did not hold, the picture would become more complicated.

To summarize, the nearest future should disclose the truth about the gold market.

Divergences - a helpful indicator of an incoming change

My readers know that I use the so-called "Gold Dollar index" to measure the internal strength of gold. Today, I would like to look at gold prices from European investors' perspective. The chart below shows gold prices expressed in U.S. dollars (the upper panel) and in euros (the lower panel):

Source: Stockcharts.com

As a rule, during a healthy bull market in precious metals, gold prices expressed in U.S. dollars and euros go in tandem. It means that each time gold prices (expressed in U.S. dollars) print a new top, gold prices expressed in euros make a new top as well. However, when there are divergences from this rule, the matter becomes very interesting. In other words, divergences are the heralds of an incoming change.

For example, look at the red arrows on the chart above. At the end of 2015, a cyclical bottom in gold prices (the upper panel) was established when gold prices expressed in the euro were in their upward trend (the lower panel). It was a very helpful, long-term divergence between gold prices expressed in two of the world's major currencies.

Now we have a similar situation (look at the two blue arrows):

  • Gold prices expressed in U.S. dollars are going up (the blue arrow on upper panel of the chart)
  • Gold prices expressed in euros are going down (the blue arrow on the lower panel of the chart)

So, once again, the basic rule has been broken and the market probably wants to tell us something important. What is it? Well, I think it is the same thing the COT report is telling us -- that we are likely ahead of a correction/consolidation phase in gold prices.

Silver market - a different world

It's an issue for another article, but let me say this: While most recently the largest world's gold investment vehicles (for example, GLD or IAU) have been accumulating gold, the largest world's silver storage -- SLV -- has been reporting huge outflows of silver:

Source: Simple Digressions

The chart shows silver flows reported by SLV this year (the row marked in blue shows monthly changes in silver prices). Note that during the current bull market stage in silver (in August and September silver prices went up by 4.5% and 2.4%, respectively), SLV reported a huge outflow of silver from its vaults (14.7 million ounces, in total). For comparison purposes, in the same period GLD and IAU reported gold inflows of 280 thousand and 1,370 thousand ounces, respectively. It means that the silver market behaves differently from its gold counterpart.

Summary

It looks as if the gold market is ahead of a correction or a consolidation phase. This thesis is supported by a dissipating buying pressure demonstrated by money managers and a medium-term divergence between gold prices expressed in U.S. dollars and euros.

However, I am not worried. I would like to see at least a short stop in this strong bull stage in gold. Generally, for healthy bull markets to last they have to be interrupted by corrections or consolidation phases. The nearest future and the way gold prices behave should tell us more about the character of the ongoing bull market in precious metals.

Note: If you liked this article, please, visit my Marketplace service (Unorthodox Mining Investing) where I am doing my own research. However, I also want to say the following: If you are looking for a guru or a person who instructs you when to buy/sell gold, I strongly advise you that my service is not for you. I am not a guru or a talking head -- I am just an independent analyst trading stocks and financial futures and … making mistakes. On the other hand, if you are looking for new ideas, an unorthodox approach to investing, decent mining picks (since inception, my Unorthodox Mining Portfolio once again delivered better returns than the broad precious metals market) and open discussion, this service is definitely for you.

Disclosure: I am/we are long GDX, CEF. 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 hold a long position in U.S. dollar futures and a short position in S&P 500 futures.