Gold's Rally Will Not Stop Here

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Includes: AAAU, AGQ, BAR, CEF, DBP, DBS, DGL, DGLD, DGP, DGZ, DSLV, DZZ, GLD, GLDI, GLDM, GLDW, GLL, GLTR, IAU, IAUF, JJP-OLD, OUNZ, PALL, PGM-OLD, PHYS, PLTM, PPLT, PSLV, PTM, QGLDX, SGOL, SHNY, SIVR, SLV, SLVO, SPPP, UBG, UGL, UGLD, USLV, USV, ZSL
by: Greenwood Investments
Summary

Gold has broken out strongly in the past weeks.

The technical charts show that gold is set to embark on a multi-year uptrend.

The technicals on two other assets which share strong historical correlations with gold add further conviction to my view that gold is set to move higher.

Gold's (GLD) breakout and upside momentum in the past few weeks have been nothing short of stellar. I first alerted readers to buy gold in "Gold on Cusp of Breakout" on June 17 when gold was trading at $1,340. In about a week's time, gold broke out $100 higher to hit $1,440.

The high-conviction call to buy gold was borne from a very mature technical pattern that has been gradually forming on the charts for a good 5-6 years. When the technical pattern was finally ripe and ready for picking, the breakout in gold was extremely swift and decisive (Read: Rocket Fuel). For the intricacies of the technical pattern and precise entry levels to ride the long gold trade, I cover these in my marketplace service The Naked Charts - you can get a two-week free trial.

The key question is now whether gold has more upside to go from current levels. My answer is a decisive yes - based on the strong negative correlations gold shares with two other assets, both of which I believe will move decisively lower in the coming weeks/months.

Weekly Chart: Gold (1 candlestick = 1 week)

The first asset I am monitoring closely is the 2 Year US Treasury yield - note the strong inverse correlation the 2Y UST shares with SPDR Gold Shares. Higher interest rates are likely to lead to selling pressure on gold, while lower interest rates are likely to support gold.

Comparison Chart: 2Y Treasury vs. SPDR Gold Shares

Chart

Data by YCharts

The main factor driving gold prices lower is swiftly falling interest rates in the US, helped on by a dovish Fed, as well as around the world. With $13 trillion of negative-yielding debts across the world, this reduces the opportunity cost of buying gold as a negative-yielding asset.

US 2 Year Treasury Yield - Weekly Chart (1 candlestick = 1 week)

Looking at the weekly chart of the 2 Year US Treasury Yield, I expect interest rates to fall further. Its rise up from 2017 to 2018 was too parabolic, which increases the risk of a sharp and painful squeeze if the market suddenly realises it has been caught out. This was what happened when the Fed reversed its hawkish policy to dovish at the start of this year. The natural supports for the 2 Year UST Yield lies around 1.20-1.30, which indicates there is still further room for yields to fall and for gold to rise, due to their historical inverse correlation.

Last week we saw more members of the Federal Reserve publicly stating their preference for lower rates. New York Fed President John Williams asserted that the central bank needed to "act quickly" should economic growth slowed, leading the market to speculate that the central bank could cut rates more swiftly than expected.

Fed Vice Chair Richard Clarida subsequently poured more fuel to fire, stating that cutting rates was a good strategy. With a 25bps rate cut already priced in as a base case for the Fed's July meeting, the focus will now turn to whether the Fed will cut rates twice or thrice by the end of the year. In summary, the Fed committee wants to push interest rates lower, and this will likely support gold prices moving forward.

The second asset I am closely monitoring is USD/JPY - which also shares a strong historical inverse correlation with gold. When USD/JPY moves higher (JPY weakens), gold prices tend to fall. When USD/JPY moves lower (JPY strengthens), gold prices tend to rise.

Comparison Chart: Invesco Currency Shares Japanese Yen vs. SPDR Gold Shares

Chart

Data by YCharts

USD/JPY - Weekly Chart (1 candlestick = 1 week)

On the weekly charts, USD/JPY has been entrapped in a descending wedge pattern, with the currency pair making a series of lower highs over time. The horizontal base at around 107-107.50 looks likely to give way under this selling pressure, which should pave the way for the currency pair to hit my target of 104.50-105.00 (Japanese Yen to strengthen against the Dollar).

USD/JPY moving lower could partially be a function of a weaker USD, borne from the Fed acting to lower interest rates. It may also indicate early signs of a more risk-off environment in the near term, as the JPY is perceived as a safe haven asset along with gold. For the latter, only time will tell, but the technical charts are currently pointing to a distinctly stronger JPY in the weeks/months ahead.

Summary

Gold has always been seen as an important diversifier in an investor's portfolio, both as a hedge against inflation and equity fluctuations. However, investors should start thinking of gold as an Alpha generator in their portfolios. Gold's technical picture has changed this year, and I strongly believe it is set to embark on a multi-year uptrend.

This week, looking at 2 other assets that share strong correlations with gold - primarily the 2Y UST and JPY, the technical outlook for all three assets point towards the same direction. This adds support to my high conviction call that gold is primed to move higher, to test the $1,550-1,600 resistance levels at the very least.

Disclosure: I am/we are long GLD, NUGT. 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.