Gold Rally Strictly A Fear-Driven Affair

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Includes: AAAU, BAR, DGL, DGLD, DGP, DGZ, DZZ, GHS, GLD, GLDI, GLDM, GLDW, GLL, IAU, IAUF, OUNZ, PHYS, QGLDX, SGOL, SLV, UBG, UGL, UGLD
by: Clif Droke
Summary

After confirming immediate-term bottom, gold price is on the upswing.

Trade war fears have been the driving force behind gold's rally.

Unless confirmed by silver, the gold rally likely isn't sustainable.

Gold’s luster is gradually returning after months of underperforming equities and other risk assets. Yet despite the metal’s improved prospects in the immediate term, there are still several key factors which haven’t lined up in gold’s favor yet. These factors, which include the performance of the silver price and the major gold mining stocks, suggest that gold’s intermediate-term (3-6 month) trend hasn’t been fully repaired yet. As I’ll argue in today’s report, gold’s rally is strictly driven by investors’ fear over the increased potential for an all-out global trade war. While this will undoubtedly help boost gold in the immediate-term (1-4 week) outlook, more is needed to justify a sustainable move above gold's February price high.

Gold has lately outperformed most safe haven assets, including the Japanese Yen, the Swiss Franc, and U.S. Treasuries. Only U.S. utility stocks have outperformed gold in the last couple of sessions, as fear on Wall Street has increased over the latest developments in the U.S.-China trade war. Gold is once again finding favor among global investors looking for a place to store wealth after liquidating risk assets. The metal’s recent progress can be seen in the following graph of the June 2019 gold futures contract.

June 2019 Gold

Source: BigCharts

In the previous report, I noted that gold had technically confirmed an immediate-term bottom per the rules of my moving average-based trading discipline. A 2-day higher close above the 15-day moving average is required to confirm a bottom, and gold has already done this. However, I haven’t recommended any new long positions in gold yet because my strategy is conservative in nature. That is, I can recommend initiating new long positions in gold only when the probability is high that a rally will continue. And for this to occur, gold’s rallies need to be confirmed by other markets within the ambit of the precious metals arena. I’m referring specifically to the silver price, gold mining stocks, and even the broad commodity market outlook to some extent. We’ll examine each of these individually in this report, but first, let’s take a look at what gold has in its favor right now.

One of the biggest factors that argues in favor of an immediate-term gold rally is the sharp reversal of its relative price strength compared to the S&P 500 Index (SPX). The following chart provides a comparison of the recent performance of the SPDR Gold Trust (GLD), the world’s leading gold ETF, and the U.S. stock market as reflected by the SPX. As you can see here, the gold ETF has decisively outperformed the stock market in the last few days after lagging it for several months. This is an important consideration for short-term-oriented traders, especially since hedge funds and other market-moving entities are more likely to buy gold (thereby pushing prices higher) when gold’s relative strength is rising versus the stock market.

SPDR Gold Trust vs. S&P 500 Index Source: StockCharts

Another factor that argues in favor of rising gold prices in the immediate term is the recent slump in the U.S. dollar index (DXY). After showing relentless strength for months on end, the dollar index has finally pulled back decisively below its 15-day moving average and is now testing its widely followed 50-day moving average (blue line), as you can see here. A weekly close below the 50-day MA would be a big impetus for an extension of the latest gold rally, but just the fact that DXY remains under its 15-day MA is helping gold. Because of the dollar’s pullback, the metal’s important currency component is now stronger than it has been in several weeks. This removes a significant impediment from gold and makes it easier for the buyers to push prices higher.

U.S. Dollar Index

Source: BigCharts

With that said, gold’s intermediate-term prospects still need to improve before the metal can be safely purchased again for those with a longer investment time line. In particular, the silver price hasn’t yet confirmed gold’s latest rally. As I mentioned in a previous report, the white metal isn’t always a leading indicator for gold but most cases silver has confirmed gold’s extended rallies. Whenever it fails to do so it usually means gold’s rally is living on borrowed time. To be exact, when silver fails to follow gold higher it usually means there is no broad institutional investment demand for either metal. Instead, a gold rally that isn’t confirmed by a silver rally can be considered as nothing more than a temporary fear-driven event on the part of individuals. And this type of move tends to end quickly once investors’ fears have dissipated.

As can be seen in the graph of the iShares Silver Trust (SLV), my favorite silver proxy, the silver ETF hasn’t yet closed above either its 15-day or its 50-day moving average. Until we see at least a 2-day higher close above the 15-day MA to confirm an immediate-term bottom for SLV, I’ll continue to hold off on recommending new purchases in gold.

iShares Silver Trust

Source: BigCharts

Meanwhile, the PHLX Gold/Silver Index (XAU) also hasn’t yet closed above its 15-day moving average yet and remains just slightly above its lowest level of 2019. I also previously emphasized the need for gold mining stocks to confirm strength in the physical gold price. A failure of the XAU index to rally along with the yellow metal is a sure sign that demand for precious metals isn’t very deep, but is instead based on temporary safety concerns among investors. For an extended gold rally lasting more than a few days, we need to ideally see the XAU index to show some improvement.

To that end, we should also see an improvement in the internal momentum of the actively traded gold mining shares. My favorite way to measure this is in the following indicator, which is based on the 4-week rate of change (momentum) of the new highs and lows of the most actively traded mining stocks listed on the major U.S. exchange. As you can see here, the short-term internal momentum for the gold stocks remains weak. This indicator also needs to improve to confirm that the mining stock outlook has improved enough to warrant an extended rally in the XAU index. This in turn would increase the likelihood that gold’s latest rally has legs and will continue beyond just a few days.

Source: NYSE

Another factor which has historically served to confirm the strength behind gold’s intermediate-term to longer-term trends is the overall market for commodities. This is measured by the benchmark Thomson Reuters/CoreCommodity CRB Index (CRB). I don’t consider it to be absolutely essential for the CRB to rally before buying gold. However, a CRB rally would certainly help increase the likelihood that gold’s rally will be sustainable beyond the very short term. The basis behind this assumption is that commodities are priced in dollars, and a weakening dollar will sooner or later result in higher prices for most commodities. As my long-time readers are aware, I consider gold’s currency component to be its single most important factor for determining the metal’s intermediate-to-longer-term strength.

A falling dollar index is thus good for gold and for commodities in general. Right now, though, the CRB index remains weak as you can see here. While not absolutely essential, it would be in the gold bulls’ best interest if the CRB confirmed gold’s latest rally.

Thomson Reuters/CoreCommodity CRB Index

Source: BigCharts

The two most important factors I’m waiting for right now, though, are for silver’s price performance to strengthen along with a strengthening performance of the actively traded gold mining shares. Some participants may protest that to wait further for a new entry point in gold is to miss a big opportunity. My response is that even if gold surges in the coming days and confirms an intermediate-term reversal there should still be plenty of opportunities to take advantage of gold’s strength by way of the individual gold mining stocks and gold miner ETFs.

Silver should also eventually present an attractive buying opportunity given how technically “oversold” it is relative to gold. On that score, the gold/silver ETF ratio shown below has now hit levels which have historically preceded periods of strong performance in silver and the silver ETFs. A confirmed bottom in the silver price is now all that's required.

SPDR Gold Trust vs. iShares Silver Trust Source: StockCharts

In conclusion, while gold has technically confirmed an immediate-term bottom and is likely to continue benefiting from high levels of investor fear, the metal’s intermediate-term outlook remains in question. To get a strong buy signal from an intermediate-term perspective, we need to first see a sympathy move higher in the silver price and in the XAU index. Until that happens, I continue to advise investors to tread with caution and wait before initiating new intermediate-term long positions in gold.

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.