All markets are driven by the emotion of fear - fear of losing and fear of missing out (greed) - and it is hard to think of a more emotional investment than gold. It has been the 'go-to' refuge from recessions and from inflation since the beginning of modern times. The emotional state of gold traders leaves "footprints" in the pricing history of gold in the form of repetitive patterns. In an article two weeks ago (here), we argued that the recent rally in gold was/is not the beginning of a new bull market in gold, and we showed that the trading patterns of gold support that view.
In this article, we review the patterns we are monitoring, and conclude that the recent bounce in the price of gold has not altered the replication of these patterns.
Gold, Silver, And Copper
The correlation between gold and silver is normally strongly positive; however, in 2012 and again in 2018, the correlation dropped suddenly before recovering. Both gold and silver seem to be replicating the pricing pattern that formed during the 2012-2016 period. The current bounce in gold and silver prices continue to fit within the pattern (chart below).
The same can be said for the correlation between gold and copper, while not as strongly positive as with silver, it is still positive on average. The similar patterns in the price and in the various momentum indicators of copper and gold continue to replicate as during the 2014-2016 trading period, despite the recent rally in gold (chart below).
In 2013, the 20-week MA crossed under the 200-week MA unleashing a zig-zagging, downward-sloping price pattern in gold that has been replicating since the middle of 2018 when the moving averages once-again crossed over.
Two weeks-ago, we wrote:
The recent bounce in gold fits with this pattern, and we think that the fear trade that took gold higher is almost exhausted and that resistance at $1,350-1,360 and $1370 will turn gold around and continue the pattern replication....If gold closes above $1,370, however, then the probability of further gains increases greatly.
Gold broke above $1370, and we now see that the decline starts from ~$1440, seventy dollars higher in price. We think that gold will decline and replicate the pattern from 2013-14 (black arrows on graphs).
A closer view of 2013-14.
A closer view of 2018-19. Notice the similarities in the technical indicators between the two time-periods. This implies a decline in gold over the next couple of months.
When we find repetitive patterns in the pricing history, we do not need to have a causative explanation for the patterns in order to trade them, but sometimes explanations are readily available. In both 2013 and 2018, there were government shutdowns, and in both 2014 and 2019 the debt ceiling was (is) in place and the government was (is) in the process of negotiating various spending bills. The debt ceiling is preventing the government from creating new Treasury debt and as @alan.longbon writes in his latest piece.
The treasury drought is adding to this problem because treasuries are required as tier 1 assets for stress tests and lending collateral and holding mandates and banks cannot get any at the moment due to the debt ceiling curtailing growth in treasury issuance. A strange rally in both bonds (TBT) and gold (UGLD) has developed as if there were a recession on the way, the former because treasuries are in short supply and the latter because gold is also a tier 1 asset and a treasury alternative.
The banks buying gold as tier 1 assets has supported the gold price, and this has excited the long-suffering gold investors by making them assume a new bull market had arrived. We do not see this as new bull market in gold. We think that over the next while, if the government is allowed to issue new debt, the buying pressure on gold as a tier 1 asset will evaporated and the price will drop. However, if that does not occur in the next couple of months, then gold could trade sideways-to-higher until the debt ceiling is raised.
Rates and the Dollar
The lack of new Treasuries has caused the price of available bonds to rise (yields drop) as buyers are willing to accept less yield. Lower yields, in turn, have a knock-on effect on the dollar causing temporary weakness in it, and upward pressure on gold. The debt ceiling must be raised within the next 4-6 weeks or else the economy might start to really falter. If the ceiling is raised, the spending (issuance of new Treasuries) will go back to normal, the dollar will rise and gold will revert to the mean (chart below).
The USD/JPY FOREX pair has a negative correlation with gold. As the chart below shows, the pair is over-sold, and gold is over-bought. This should put downward pressure on gold (chart below).
The Technical Take
Gold continues to be technically over-extended:
- RSI is dropping from overbought levels.
- MACD is elevated and converging.
- Stochastic is dropping from overbought levels.
- +DI of the ADX is elevated and heading lower.
Gold failed to close above the August 2013 high of $1440, and if it drops below $1370, it will have failed the breakout and will drop to test lower supports. (chart below).
In summary: Gold's upward movement has been driven mostly by the repercussions stemming from the debt ceiling and the Treasury's inability to issue new debt. When the debt ceiling gets raised, rates will stabilize, the dollar will rise, the purchasing of gold as a tier 1 asset will diminish and god will revert to the mean--thereby replicating the historical trading patterns.
During the 2018 correction, our analysis showed that we were not at the start of a new bear market and that the bull market was not in the process of ending. As a result, our subscribers avoided the herd mentality of panicked-selling and the losses it created.
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Disclosure: I am/we are short GDXJ. 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.