Gold Lost Its Shine

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Includes: AAAU, BAR, DGL, DUST, GDX, GDXJ, GLD, GLDM, IAU, JDST, JNUG, NUGT, OUNZ, RING, SGDJ, SGDM, SGOL, UGL, UGLD
by: ESI Analytics Limited
Summary

Gold reached our target during the past trading week.

Behavioral data signals excessive speculation in gold.

Technical patterns show early signs of exhaustion.

We expect a correction that lasts a few months and prefer to stay on the sidelines.

Gold reached exactly into our 1,500-1570 target, which we discussed here during the past months. We are turning bearish on gold as technical and behavioral evidence signals headwind. The precious metal is likely to correct during the next few months.

Gold traded into our target. That's it with the good news, which allowed us to catch some great trades over the past year. The bad news is that gold is likely to correct going forward. We arrive at this conclusion from our analysis of investor behavior and chart patterns.

There is an overwhelming consensus that gold is the best asset to own these days. The fundamental reasoning roots most often on central bank policy and the debt cycle in western economies. Public figures like Ray Dalio presented once again arguments in favor of a bullish outlook for gold. We could fill pages with other prominent figures stating an optimistic opinion on gold lately. Instead, we take a look at the data. The CFTC's Commitments of Traders report shows excessive speculation in gold.

Money managers and large speculators are approaching record levels of long exposure in the precious metal. Each of the past corrections in 2011, 2016, and 2018 started on the back of a similar positioning picture. The daily sentiment index, which tracks the sentiment of traders reached a proportion of 98% bulls last week. It is a top 0.5 percentile result throughout the 32-year history of the index. Subsequently, gold corrected for at least a few months.

CoT Report - Gold

Source: CFTC/barchart.com

The technical picture most likely confirms the contrarian signal from sentiment. Gold broke above a multi-year sideways correction, which is depicted in pale red on the chart below. The rally shows a complete A-B-C pattern, which probably ended on Monday. Gold spiked into a long-term resistance, which formed during the topping process 2011-2012. The pale yellow box depicts the respective resistance. Divergence signaled exhaustion and led to a sell-off as news about delaying tariffs on specific Chinese products hit the wire yesterday. The drop was swift and impulsive. Overall, technical evidence suggests a nearby top unless prices manage to break sustainably above 1,550.

EW Analysis - Gold Source: scienceinvesting.com

Fund flows show that liquidity flows from risky assets into money market and bonds. It may not be intuitive but could affect gold as well. The reason behind that is that investors think of having discovered the holy grail of asset management by implementing a very simple strategy - risk parity. Tremendous amounts of money got channeled into that strategy and gold makes up the largest single position within that strategy. Many do-it-yourself ETF portfolios are floating around the financial media. Sentiment and positioning are fully fledged in extreme territory for all ingredients of the risk-parity strategy at the time of this write-up. Hence, there is an elevated risk that investors unwind some funds from the strategy.

Money Market Flows

Source: Sundial Capital Research

All in all, gold has probably lost its shine and is likely to correct for the next few months. This conclusion is based on behavioral and technical analysis. We prefer to stay on the sidelines and evaluate the correction as and if it unfolds.

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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. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: We distributed this idea to our clients on August 14th 2019.