Gold, XAU Riding A Strong Momentum Wave

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Includes: FXI, GDX, IAU
by: Clif Droke

Summary

Gold rally becomes over-stretched but still on track for strong January.

Market sentiment and seasonal factors favor the bulls in early 2018.

Gold also should get a boost from China demand going forward.

Gold reached its highest since late September on Tuesday, extending a year-end rally in which the gold price gained over 4 percent in the last three weeks of 2017. In this commentary, we'll examine gold's near-term prospects as we answer the questions, "Is the gold rally over-stretched?" and "How much more upside potential does the gold price have in January?" To that end, we'll look at some positive factors which should favor the gold bulls in the early part of 2018.

The gold futures price was up 1.28% at $1,319 on the first trading day of 2018, while spot gold also closed with a respectable gain to a more than three-month high. Meanwhile, spot silver was up 1.1 percent at $17.13. A weakening U.S. dollar, which posted its biggest annual drop since 2003 last year, helped buoy gold by more than 13 percent in 2017. The metal surged $55 an ounce in the last three weeks of the year alone.

On the technical front, many market analysts believe that the gold price is becoming vulnerable to a pullback after the impressive rally over the last eight trading sessions. When we look at the daily gold futures chart (basis February) shown below, there's no question that the price line is quite distended from the underlying 200-day moving average. The 200-day MA is arguably the moving average used most by investors and market technicians. Whenever the price line pulls too far away from the 200-day MA (above or below it), the market tends to become more vulnerable to a "reaction" in the opposite direction of the prevailing trend. Thus, there is at least some technical basis to worry about a pullback in the coming days.

February Gold

Source: www.BigCharts.com

However, even if there is a pullback in the gold price, the bulls still enjoy a decided technical advantage over the bears and should be able to keep gold's short-term uptrend intact. There is a fairly strong amount of price momentum behind the rally which began last month, as the 12-day momentum indicator reveals in the above graph. There is also an anecdotal reason for believing that the gold bulls have things well in hand: since the early December gold sell-off bottomed out, there seems to be much less interest in the yellow metal among retail traders. At least that's the message I'm getting from my readers and fellow analysts. Apparently, many weak-handed gold bulls were shaken out of the market by the early December bear raid. Thus, the stage was evidently set for the strong rally now that the gold "long" trade is no longer overcrowded.

Last month, after the gold price low was established, I discussed the possibility that there would be a meaningful rally in January based on historical/seasonal tendencies in the gold market. So far this historical pattern hasn't disappointed, and with the weakening U.S. dollar index (DXY, below) showing continued weakness, the odds are still high in favor of a strong January performance for gold.

U.S. Dollar Index

Source: www.BigCharts.com

There is another consideration that traders need to consider, however. The rules of my technical trading discipline state that a confirmed buy signal occurs when gold has closed at least two days higher above its 15-day moving average following a sizable decline. This criterion was met on Dec. 20. The rules of my technical trading discipline also state that the first profit in a newly established long position should be taken whenever the price rallies by 4-5% from the initial entry point. In gold's case, that would be the $1,320-1,333 area. February gold reached an intraday high of $1,323 on Jan. 2, which means that the minimum upside objective of the immediate-term (1-4 week) trading positions have been realized. Thus, conservative traders might consider taking some profit this week. I also recommend raising the stop loss on existing long positions to slightly under the $1,274 level, which is where the 15-day moving average is currently found in gold's daily chart.

Another factor which should weigh in gold's favor in the early part of 2018 is one of the gold market's biggest participants. I'm referring of course to China. China's stock market is in a strong technical position right now, which is in part a reflection of the country's economic strength. Historically, a strengthening Chinese economy has equated to increased gold demand for China on both the consumer and industrial levels. From this perspective, the rising trend visible in the iShares China Large-Cap ETF (FXI) - my favorite proxy for China ADRs - can be viewed as a harbinger of future gold price strength.

iShares China Large-Cap ETF

Source: www.BigCharts.com

On the mining stock front, the PHLX Gold/Silver Index (XAU) kept its immediate-term uptrend alive on Tuesday with a 3.36% gain. The XAU confirmed an immediate-term bottom on Dec. 15 by closing two days higher above its 15-day moving average and has remained above the rising 15-day trend line ever since. It's constructive that the gold mining stocks have shown relative strength versus the gold price, and the XAU turnaround preceded gold's confirmed bottom signal by a few days. This is another reason for believing that gold is currently being held in strong hands since the best gold rallies have occurred when the XAU has shown leadership.

PHLX Gold/Silver Index

Source: www.BigCharts.com

Internally, the actively traded mining shares are still in good shape as can be seen in the following graph. This shows the two directional components of my gold stock internal momentum (GOLDMO) index. GOLDMO tells us the path of least resistance for the 45 most actively traded mining stocks under the assumption that the rate of change (momentum) of the new highs and lows of these stocks best reflect the incremental demand for them.

The blue line in the following graph signifies the four-week rate of change of the ten-week new highs-lows; the red line is the six-week rate of change. Both indicators are confirming the XAU rally, and as long as they remain in a rising trend it is assumed that the near-term path of least resistance for the gold stocks as a group is up.

Chart created by Clif Droke

For disclosure purposes, I am currently long the VanEck Vectors Gold Miners ETF (GDX), which is my favorite proxy for the XAU index. GDX confirmed an immediate-term bottom on Dec. 20 after closing two days higher above the 15-day moving average, per the rules of my trading discipline. For traders who wish to participate in the gold stock turnaround via GDX, I recommend using the 22.00 level as the initial stop-loss on a closing basis. I'm also currently long the iShares Gold Trust ETF (IAU), which is my preferred tracking vehicle for the gold price. I recommend using a stop loss slightly under IAU's 15-day moving average at the 12.18 level (closing basis).

Disclosure: I am/we are long GDX, IAU.

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.

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