Gold Strictly A Stock Market Hedge For Now

Includes: IAU, SLV, UUP
by: Clif Droke

Gold's immediate-term rally prospects tied to equity market weakness.

The yellow metal still doesn't enjoy support from its two closest allies.

Dollar index reversal would give gold buyers a decisive advantage.

In recent reports, I’ve made the case that gold’s near-term health is inversely tied to that of the equity market. The events of recent days have shown that whenever investors are infected with a case of the jitters and dump stocks, gold has benefited. Gold has been held back from a major rally, however, due to factors beyond mere safety concerns. In today’s report, we’ll examine these factors as I build the case that while stock market weakness will benefit gold, a sustained gold rally is contingent upon increased strength for silver and the gold mining shares. Without strong participation from both, the prospect for a sustained gold price rally is significantly diminished.

Equities took a dive on May 23 after trade tensions escalated between the U.S. and China. No further trade talks have been scheduled after the most recent talks ended with no agreement to end the tariff dispute. The latest drop in the Dow and S&P 500 indices gave traders a reason to look to gold for protection from the broad market weakness. Gold prices rose 1% intraday on Thursday amid rising concerns over the parlous state of U.S.-China trade. Also supporting gold lately has been the ongoing Brexit saga as Britain’s Prime Minister Theresa May was widely expected to soon announce her resignation.

Indeed, gold has plenty of safety-related demand in the immediate term. It can also launch a short-covering rally based solely on the prevailing level of fear among investors. In order to sustain a rally, however, gold needs more than just the “fear factor.” In order for gold to cease being merely a temporary hedge against a weak stock market, support from its sister metal, silver, is needed. Also required for a healthy and sustainable gold rally is increased strength in the actively traded gold mining shares. A closer examination of both factors is therefore warranted.

Gold’s most important supporting factor in my estimation is its sister metal, silver. As I’ve argued in recent reports, without a corresponding rally in the silver price, it’s hard to make a case for an extended gold price rally. Typically, when there is intermediate-term (3-6 month) investment demand for gold, silver and other precious metals benefit. Intermediate-term investment demand is more than just a concern for safety and is usually founded on considerations such as a weaker dollar or higher inflation outlook. The impact of industrial demand for silver and other metals is another factor which hinges on a strong global economy. None of those factors are currently visible as fear remains the dominant motivation for investors to own gold.

Shown here is the iShares Silver Trust (SLV), which is my favorite trading vehicle for the white metal. SLV has been in a steady decline for months in reflection of the strong U.S. dollar and weakened industrial demand for the metal. However, in recent days, there has been a noticeable bottoming attempt in the silver ETF and Thursday’s (May 23) fear-induced gold rally also produced a corresponding 1% rally in SLV. This is a promising move in the right direction for silver. If SLV can confirm an immediate-term (1-4 week) bottom by closing two days higher above its 15-day moving average next week, it would also serve to validate gold’s bottoming attempt of recent weeks. A sympathetic move higher in silver would also justify initiating a new short-term long position in gold.

iShares Silver Trust

Source: BigCharts

Arguably, the most important factor which would pave the way for an extended move higher in both metals is for the U.S. dollar to weaken. The Invesco DB U.S. Dollar Index Bullish Fund (UUP) is my favorite dollar-tracking vehicle, and it’s currently still above its rising 15-day and 50-day moving averages on a weekly closing basis. That’s enough of a show of strength to where gold and silver will have a difficult time maintaining a rally for more than a few days.

In order for the outlook for both precious metals to appreciably approve, we should see UUP close decisively below both moving averages. It has been months since the dollar ETF closed under its widely-watched 50-day MA on a weekly basis, and doing so would serve as a catalyst for a potentially major gold short-covering rally. Since gold is priced in dollars, a weaker dollar index is the one thing that would guarantee the gold bulls can take control of the metals’ intermediate-term trend with relative ease.

Invesco DB U.S. Dollar Index Bullish Fund

Source: BigCharts

Meanwhile, the iShares Gold Trust (IAU) has steadfastly withstood the dollar-related selling pressure which has plagued silver and other metals in recent months. After confirming an immediate-term bottom per the rules of my trading discipline earlier this month, IAU has slipped below its 15-day MA once again, however, and its immediate-term trend is in need of repair. As of May 23, IAU is barely above its 5-month low and is also under the psychologically significant 50-day MA. There is obviously a need for further technical improvement before I recommend another trading position in IAU. The latest trading position I recommended last October proved to be well worth our participation, and if the other factors mentioned in this report soon align with gold, we could well have another such buying opportunity in the weeks ahead.

iShares Gold Trust

Source: BigCharts

A final consideration when evaluating gold’s rally prospects is the technical condition of the actively traded gold mining stocks. Currently, the PHLX Gold/Silver Index (XAU), which is widely regarded as the benchmark for the gold miners, is at its lowest level in almost six months. This doesn’t argue very strongly in favor of buying gold right now for anything more than speculative purposes. To get a solid, high-probability intermediate-term buy signal for gold, we should also see corresponding strength in the XAU index. Gold mining stock investors apparently aren’t convinced that gold is ready to take off again on the upside, otherwise, we would surely see a vigorous rally in the XAU.

As reflection of the relative weakness in the mining shares is the following graph. This graph shows the 4-week rate of change in the new highs and lows of the 50 most actively traded gold mining and exploration stocks. I view this indicator as a reflection of the near-term path of least resistance for the gold stocks. The new highs and lows are one of the best reflections for the demand for gold stocks, and if this indicator is trending lower it suggests that informed investors aren’t interested in buying the gold miners right now. Until this indicator reverses its decline, I recommend that invest

Source: NYSE

While the gold price will no doubt benefit from additional weakness in the U.S. stock market, before its 3-6 month prospects improve, we should see a sharp decline in the U.S. dollar index. Dollar weakness would support both gold and silver and would make it easier for the precious metal bulls to control the intermediate trend. Additionally, increased strength in the gold mining stocks would argue in favor of higher gold prices beyond the very short term. For now, a continued defensive stance is recommended due to the cross-currents still plaguing the precious metals sector. No new trading positions are therefore advised until we see the improvements outlined here.

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.