Remember What Happens To Gold In December

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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: Andrew McElroy

Summary

If you are a gold bear at these lows you have a short memory.

December declines are a buying opportunity.

Why buyers shouldn't fear the Fed.

The market has a long memory. Unfortunately most traders have very short memories. Many are caught up in catching the next few pips and forget to set context so they can catch the next big move.

This article is a simple reminder of what often seems to happen to gold (GLD) in December.

Since 2013, every sell-off in December has led to a sizable rally in Q1 of the next year.

In 2015 and 2016 the December low also happened to line up with a Fed rate hike. The extended sell off into the hike combined with overly bearish sentiment led to significant reversals. The below chart shows gold's response to every hike in this cycle.

The response to the hikes in December 2015, December 2016 and March 2016 are comparable. June 2016 less so; perhaps the market had not sold off enough into the hike and was already too long in anticipation of a rally.

This time however, gold has sold off quite significantly ahead of the expected hike next week. It is down over 7% from the September highs and sentiment is at the opposite end of the spectrum from a few months back. Remember all the $1300 break-out bullish articles? Some of the same guys are now suggesting we sell.

Don't Fear the Fed

We have to ask why a rate hike would be bearish for gold anyway. Gold is related to many markets, but has practically no correlation to the Fed Funds Rate, at least in this hiking cycle.

If anything, it has a positive relation.

Gold correlates much more with long term rates (TLT) - shown below in red - and the Fed has very little influence over these.


Actually TLT has been ticking up in December while gold falls. Perhaps it is leading gold higher, but of course the divergence could be resolved the other way.

Gold ignoring short term rates and following longer term rates is actually something which has been happening in other related markets. Wells Fargo published a note this week showing how the Euro Dollar has largely ignored the 2yr rate differentials and followed longer term rates. EURUSD (FXE) is therefore much less sensitive to rate hikes.

Trading Strategy

Since the conditions are right for a December reversal, I am looking to buy gold for a move back over $1300 and towards the $1357 high. I don't think it can make a new high, but I can always change my mind during the rally; what I want to know now is that there is enough potential reward to justify the risk of buying.

We should also be aware gold can move down sharply after the hike like it did in December 2016. It bottomed the next day, but if you were all in with a tight stop you would have been shaken out. Therefore I am taking a fairly small initial position with a wider stop.

Talking of shake outs, the technical break-down in recent sessions could have stopped out a few traders.

Breaking the 200 day moving average and the channel looks scary, and the drop could extend to $1256 before it reverses. However, once back over $1270 the recovery should gather strength and set up a rally in Q1 2018.

I am buying in the $1250-60 area (actually I am already long a small amount at $1273) with a stop below $1230. I will add when convincingly over $1270. This trade therefore has around 2:1 reward to risk ratio. i.e. $35 risk and $70 reward to target the $1340s. Once back over $1270 I can increase the ratio by adding more size with a tighter stop.

Conclusions

Gold is selling off ahead on next week's expected rate hike and sentiment in the precious metals is pretty sour. But all is not lost. The same set-up has been present for the last two years and both times they led to a significant rally. Gold buyers have no need to fear the Fed.

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.