The Gold Market Holds Its Breath For December

by: Andrew Hecht

Gold recovered from the lows in August.

December has been an ugly month for the yellow metal.

The Fed is ready to act, but their statement will determine the price path for gold.

The dollar has prevented gold from challenging any resistance levels on the upside.

While December has been rough, January has been a different story. UGLD on a dip in December could lead to a happy New Year for bulls.

Gold is in a holding pattern during the final days of November and has been trading in a range from $1216.80 to $1236.70 since November 16. The gold market has gone to sleep as the dangerous month of December approaches.

Gold recovered from the mid-August low which is the bottom for 2018, so far. The price of the now active month February futures contract traded to a low of $1173.20 per ounce when the dollar index rallied to a new high at 96.45. Even though the dollar has made new highs since then, the price of gold has not revisited its lows from August. The latest peak in the dollar index came on November 12 when the December futures contract hit 97.53. However, gold barely made to the $1200 level as the dollar appreciated and found a bottom at $1202.40 on the December contract on November 13 the day following the high in the dollar. Gold's performance has been impressive since August, but the yellow metal is far from out of the woods these days as the final month of 2018 is upon us.

Gold has had every reason to move to the downside over the past few weeks, but it remains at the $1225 level. The sign of strength in an environment that should be causing weakness is a good sign for the price path of the yellow metal. For those who are looking to buck the trend of the past three years in the gold market, the Velocity Shares 3X Long Gold ETN product (UGLD) could be the perfect tool. For those looking for a repeat performance of year's past DGLD, the complementary bearish product, offers the opportunity to magnify moves on the downside in the gold market.

Gold recovered from the lows in August

The continuous contract in the COMEX gold futures market traded to a low of $1161.40 in mid-August while the February futures contract moved to bottom at $1173.20 per ounce. Since then, the February contract has been making higher lows.

Source: CQG

As the daily chart highlights, the price recovered to a high at just over $1225 at the end of August and then fell to a higher low at $1190.00 on September 28. The next high on the active contract came in late October at $1252, which led to another correction down to $1202.40 following the new peak in the dollar index in mid-November. As the eleventh month of 2018 comes to a close, gold is trading at the $1226 per ounce level as of November 30 with the dollar index at just over 97, higher than where it was when gold fell to its low for the year in mid-August. The daily chart shows that price momentum continues to rise and has entered overbought territory while relative strength displays a neutral condition. Open interest, the total number of open long and short positions in the COMEX futures market has declined from a high at 539,520 contracts on the day gold reached its most recent low to 390,899 contracts on November 29, a fall of 148,621 or 27.5% as December futures rolled to February 2019, the next active month. Gold has moved higher as the metric plunged which is not typically a technical validation of the bullish move in a futures market.

The gold market continues to face a higher greenback, the prospects for higher interest rates and a stock market that threatens to deteriorate into a risk-off period across all asset classes because of the ongoing trade dispute between the U.S. and China. However, gold could now be facing its most significant challenge of the year as it enters a month where it has moved to lows over the past three years.

December has been an ugly month for the yellow metal

December had been a rough month in the gold market in 2015, 2016, and 2017.

Source: CQG

As the weekly chart illustrates, the precious metal fell to a low at $1046.20 in December 2015 which was the lowest level since early 2010. In 2016, the price found a low in December at $1123.90, which was the lowest price in 2016 since the first week of February of the same year. Last year, the low in gold during the final month of the year was at $1236.50, the lowest price since mid-July of that year. Gold developed a habit of bearish price action during December and holiday season. Time will tell if the holidays came early in 2018 as the low in gold occurred during mid-August and the yellow metal is going into the final month of the year on a firm note.

The Fed is ready to act, but their statement will determine the price path for gold

One of the leading reasons for price weakness in the gold market in December is that the U.S. Federal Reserve hiked the short-term Fed Funds rate by 25-basis points in each of the past three years. In 2015, liftoff from a zero percent rate was at least a partial cause for the price weakness in the gold market which had been declining since the 2011 high at over $1920 per ounce. Gold found a bottom in December 2015 and as of yet has not returned to a price under the $1120 per ounce level. The next rate hike came in December 2016 which again corresponded with a weak period in the gold market. In 2017, the Fed acted three times to increase the short-term rate with the final move coming at their December meeting. In 2018, the central bank continued to up the ante with a total of three 25-basis point increases already and a fourth coming at their December meeting.

The Fed has done an excellent job preparing the market for rate hikes, and the next hike that will take the short-term rate to 2.25-2.50% is likely baked into all markets. Therefore, the devil will be in the details when it comes to the December 2018 meeting of the FOMC as their plans for 2019 and beyond will drive the value of the dollar, gold, and markets across all asset classes.

Most markets have reacted to a more hawkish approach to monetary policy and the rote process of allowing the legacy of quantitative easing to roll off the Fed's swollen balance sheet throughout 2018. Stocks have been volatile and the bull market that had been in place for years has hit more than a few speed bumps. Meanwhile, a continuation of a hawkish rate policy could cause selling in stocks, buying in the dollar, and selling in gold and other commodities. However, the recent weakness in the stock market, a slowdown in global economic growth, and fears surrounding international trade could cause the Fed to put on the brakes when it comes to tightening credit. The latest comments from Chairman Powell last week indicated he may be softening his hawkish approach to monetary policy.

The central bank watches economic data like a hawk, and their use of short-term interest rates is a function of responding to growth or contraction. The most recent signs could cause a surprise at the December meeting if the Fed decides that instead of the three 25 basis point rate hikes they initially indicated would be coming next year, they conclude that only two moves are necessary. A retreat from their tightening could light a bullish fuse under the gold market which is holding these days with one eye on the central bank and the other on the dollar.

The dollar has prevented gold from challenging any resistance levels on the upside

A strong dollar has stood in front of any appreciable rally in the gold market throughout 2018.

Source: CQG

The dollar index fell to a low at 88.15 during the week of February 12. The strength in the dollar index has been a function of the ever-widening gap between the dollar and euro currency short-term interest rates which are likely to stand at 2.65-2.90% at the end of December. The euro accounts for 57% of the dollar index, and the ECB has kept rates at the negative forty basis point level as the Fed Funds rate has moved higher since late 2015.

While the dollar was on its low this year, the price of gold was trading just above the $1360 per ounce level; a stone throw's away from the area of technical resistance at the July 2016 peak at $1377.50. The dollar index turned higher and has been making higher lows and higher highs since the February lows, and at 97.175 on November 30, it was just over 10.2% above the lows of the year. Meanwhile, the high in gold this year was a double top from late January and mid-April at $1365.40. At $1226, gold is 10.2% below its peak for the year. At the same time, the yellow metal is 5.6% above its low.

While the dollar has prevented gold from moving higher over the past weeks and months, the yellow metal ignored the most recent new high in the dollar which is a sign that there could be something brewing in the gold market. The volatility in the stock market could be driving some capital flows into gold, but the recent action in open interest is telling us that market participants are exiting positions. There are conflicting signals in the gold market these days, but the month of truth is upon us next week as December is a month that has not been good to gold bulls since late 2015.

While December has been rough, January has been a different story; UGLD on a dip in December could lead to a happy New Year for bulls

Past performance is never a guaranty of future results, but it can be a good indicator. History rarely repeats exactly, but it does rhyme over time. We could be in for a volatile month during this holiday season with the first trade on Monday, December 3, 2018.

We could see lots of two-way activity December. As the Fed meeting on December 18-19 approaches, the market will anxiously await the statement from the central bank outline their intentions for the coming year. All of the ingredients in global markets could add up to some wide price variance in the gold market between now and the start of 2019.

One of the most direct routes for trading or investment in the gold market is via the futures and futures options that trade on the COMEX division of the CME. For those looking to magnify those moves using leverage in their standard stock trading accounts, the Velocity Shares 3X Long Gold ETN product (UGLD) and its complementary short gold product (DGLD) can turbocharge the percentage moves in the gold market over the coming month. The fund summary for UGLD states:

The investment seeks to replicate, net of expenses, three times the S&P GSCI Gold index ER. The index comprises futures contracts on a single commodity. The fluctuations in the values of it are intended generally to correlate with changes in the price of gold in global markets.

The DGLD product has the same summary, but it gains its leverage using inverse tools to achieve triple results. Both UGLD and DGLD suffer from time decay which is the price tag for turbocharged ETN products. There is no free lunch when it comes to the derivative markets. In exchange for the leverage afforded by these products, they decay over time and can suffer from reverse splits that destroy value. Therefore, timing is everything when buying the UGLD and DGLD and they are only appropriate for very short-term trading or investment purposes in the gold market.

The price of gold fell from $1238.40 on November 7 to $1196.60 on November 13, a decline of 3.38% on the December futures contract.

Source: Barchart

Over the same period, the DGLD ETN moved from $52.54 to $56.70 or 7.9%, a bit under a triple magnification of the move in gold to the downside.

December gold then rallied from $1196.60 on November 13 to a high of $1230.90 on November 21 or 2.87%.

Source: Barchart

Over the same period, UGLD rallied from $78.98 to $85.26 per share or 7.95%. While both ETNs fell shy of their triple performance levels, they did magnify the moves in the precious metal on the up and the downside. UGLD has net assets of $128.40 million and trades an average of 129,848 shares each day. DGLD's net assets are at the $19.41 million level and trades an average of 76,770 shares on a daily basis. Both products offer reasonable liquidity for short-term turbocharged forays into the gold market.

Meanwhile, gold mining shares tend to be even more volatile, so the Direxion Gold Miners Bull 3X ETF (NUGT) and its bearish counterpart (DUST) offer even more leverage in the gold market when it comes to increasing percentage performance in the yellow metal. In a sign of how derivative instruments attract lots of market participants these days, NUGT trades an average of over 10 million shares each day, and DUST's average daily trading volume is over 2.17 million shares.

There are many products available to magnify daily trading performance in the gold market. A volatile December in gold will result in lots of action in the leveraged ETF and ETN markets for gold and gold mining shares.

Gold is going into the final month of the year at a level where it could go either way. I will be watching the price action and will go with the flow over the coming days and weeks using these tools to enhance my portfolio.

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: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.