By David Brady, CFA
The title to last week's article began with "Gold stuck in limbo," and although not very sexy, it was spot on! We're still stuck in that limbo, and silver and the miners are trapped there too. But based on yesterday's price action, we may get resolution one way or the other very, very soon. Recent developments suggest it could be to the downside.
It remains "risk on" and stocks continue to move higher reducing the need for rate cuts or QE anytime soon. In fact, for all of the talk about rate cuts and the transition from QT to QE recently that has supported the massive rally in stocks off their December lows, few were talking about this nugget in the FOMC minutes on Wednesday:
"Some participants indicated that if the economy evolved as they currently expected, with economic growth above its longer-run trend rate, they would likely judge it appropriate to raise the target range for the federal funds rate modestly later this year."
This was followed by:
"In their consideration of the economic outlook, members noted that financial conditions had improved since the beginning of year."
Former NY Fed head William Dudley has said on a number of occasions recently that he expects the Fed to raise rates again in September due to a marked improvement in financial conditions by then (code for a higher S&P), stronger economic data, and higher inflation numbers.
At the same time, the 10-year Treasury bond yield is 16 basis points off its low of 2.34%. Real interest rates have stopped falling as a result and may instead start to rise. Lower yields and real interest rates have both been supportive of higher gold and silver prices since November.
The lower likelihood of easier monetary policy due to rising stock prices coupled with higher bond yields are two reasons to be concerned about the next direction for the precious metals and miners.
The morning of the FOMC minutes, European Central Bank President Draghi said the bank was "READY TO ADJUST ALL INSTRUMENTS AS NECESSARY" to support economic growth in the EU. Zerohedge said it better with this headline: "Euro Tumbles After Draghi Issues 'Whatever It Takes' 2.0 Statement."
This signaled that after just over three months since the ECB ended its QE program, it has been forced to not only to turn it back on but may also have to do a whole lot more this time around.
Naturally, the euro weakened and the dollar rose. The dollar's correlation with gold has been weak recently, but rising steadily. Its correlation to silver has been higher. Simply put, a stronger dollar that could reach new highs in the coming days and weeks would also weigh on gold.
The biggest risk in the near-term is from the banks. We have seen some sharp moves lower recently that have lasted anywhere between an hour and a day that have all the hallmarks of forced selling driven by the banks.
The latest iteration of this has been massive spikes in open interest where the net position of the banks remains the same, but both their long and short positions rise significantly. The rationale for such an increase in gross positions is "spread hedging," but it is more likely just another strategy to push prices lower and profit on it at the same time.
They do this by selling the long positions they are holding and thereby becoming net short. In the process of selling their longs, they are forcing other longs to cover their positions also, and down goes the price. Then the banks cover their short positions at the lower price and open interest returns to its previous level like nothing happened. But the price has fallen a significant amount in the interim.
The 200-day and 200-week moving averages are at 1,253 and 1,244 respectively. The banks like to target these averages to trigger algo selling on top of any selling they are doing, driving the price even lower. Should support at 1,280 in gold break, then we are likely to see a test of these levels shortly thereafter.
The same goes for the miners. The 200-day and 200-week moving averages in GDX are at 20.55 and ~21 respectively. A break of support at 21.50 virtually guarantees a test of these levels. If the triple bottom at 20.22 is broken, it could get ugly on the downside.
The key support zone in silver is 14.45-14.60. Below there and expect a 13 handle again.
At the same time, if the following levels were taken out, this could change the momentum back to the upside: Gold 1,315, silver 15.31, and GDX 23.
- The Fed has done a verbal 180 on policy, paused interest rates, and both reduced and set a terminal date for the balance sheet reduction program.
- The ECB has also pulled an actual 180 on its QE program just 3 months after it supposedly ended.
- The Public Bank of China (PBoC) printed 5% of its GDP in January alone.
The Central Banks are already turning the spigots back on and stocks are rising again. As long as the Fed can keep the stock market rising and cap bond yields without having to reverse course to rate cuts and QE or trash the dollar, the higher the probability Gold, Silver, and the Miners could come under pressure again.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.