By David Brady, CFA
Gold continues to set higher and higher lows on a daily and weekly basis. The trend is clearly up, and until some kind of support is broken, the trend must be respected.
The first such support on a daily basis is at 1488. Then it's 1400, and 1300 below there.
On a weekly basis, we need to go all the way back to critical support at 1267 for a potential change in the overall trend.
Resistance is at the recent high of 1546 and 1588, the 61.8% Fibonacci retracement of 1923 to 1045, the peak in 2011 and trough in 2015, respectively.
In addition, all of the daily moving averages are trending higher, with the 20-day > 50D > 100D > 200D. I would prefer to see the 20-day cross below the 50-day to seriously consider a change in trend to the downside.
The Fed cut rates last month for the first time in ten years, with several more already priced in. QT was also ended early. The Fed is clearly on a path towards a return to zero interest rates (and possibly negative) and, most importantly, QE. Bond yields have tumbled as a result. The dollar index appears to have peaked at ~99 in the process, as yield spreads between the U.S. and other major countries narrow.
This has consistently been my primary scenario for the bottom and rally in metals and miners going back to December 2017 and in my articles for Sprott Money since.
The only caveat here is if a trade deal is reached between the U.S. and China, which sends stocks soaring and reduces the need for rate cuts. While I still consider any substantive deal to be an extremely remote possibility, given the pending Presidential elections next year, some kind of deal cannot be ruled out altogether.
When real yields (nominal yields less inflation) are falling, Gold tends to rise. Treasury Inflation Protected Securities ("TIPS") are the mirror image of real yields and tend to move parallel with Gold from a price perspective. Simply: when real yields fall, TIPS prices rise and Gold rises, as long as they remain correlated.
Well, TIPS have been soaring since November last, and so has Gold. The problem is that the RSI and MACD Line are at their most extreme since the August 2011 peak in Gold, and the MACD Histogram is negatively divergent. That said, as long as treasury yields are falling and inflation is rising, real yields will continue to drop, TIPS will rise, and so will Gold.
Watch for any rise in bond yields and/or drop in inflation as a warning sign for Gold. A breakdown in the correlation with Gold leading the way down would be another.
We have now risen 35% from 1167 in the past year and 22% from 1267 in May. While I remain a medium and long-term bull, the risks are growing in the short term.
Gold is extreme overbought across all time frames:
- Daily RSI: 78, and negatively divergent. Down from its highest level since February 2016, which preceded its negatively divergent peak the following July.
- Weekly RSI: 83, its highest RSI since the peak in August 2011 at 85.
- Monthly RSI: 73, also at its highest level since August 2011.
The daily MACD Histogram is also negatively divergent. The MACD Line is at its highest since March 2016.
The weekly MACD Histogram reached its highest level since March 2016, and the MACD Line its highest level since November 2011. Plenty of room to fall here.
The monthly MACD Histogram is negatively divergent to the peak in July 2016.
It's safe to say that although we have broken out to a new high, Gold is extreme overbought across all time frames and negatively divergent, which is clearly bearish. That said, it can continue higher until the trend breaks down.
Headlines like this from CNBC yesterday show just how extreme bullish Gold is these days:
Gold could hit $2,000 in a world full of negative yields
Everyone seems to think it will just keep going straight up. The notion that every trend has peaks and troughs is a foreign concept. Even Bitcoin had its pullbacks during its parabolic rally. The mere suggestion of a reversal brings out every troll and every excuse imaginable for why Gold should continue higher. Point out hyperbolic nonsense to the publisher and everyone runs to their defense. Suffice to say, the boat is almost completely full on one side, and that typically signals trouble ahead.
Gold's weekly COT data for the past five years, below, shows the peaks and troughs in Funds' and Commercials' net positions as a percentage of open interest relative to price. Commercials are now at -54%, with only July 2016 peak even higher at -56%, and that was as of last Tuesday.
Commercials net short of -54% of open interest also matches "the top" in August 2011 and was just short of the October 2012 peak at -56%.
In fact, since 2006, Commercials were only this short at the peaks in July 2016, October 2012, August 2011, March 2008, and May 2006. If you bought before these dates, you had to weather the following losses:
- May '06: 23%
- Mar '08: 30%
- Aug '11: 46%
- Oct '12: 42%
- Jul '16: 18%
In today's terms, that would mean a drop to 1262 minimum, 840 max.
The argument that "we are now in a bull market, so these don't matter" holds no water. We were in a bull market on each of those occasions too. Gold remained in a bull market after four of those five occasions, save for October 2012, so we don't need to suffer a bear market for a big drawback to occur. 1270 would still mean a higher low, not that I expect such a big drop.
Suffice to say that Commercial positioning is extremely bearish by historical standards, yet we still need to see a break of support before these truly do matter.
Gold in dollar terms (XAU/USD) = XAU/CNY divided by USD/CNH. What happens to XAU/CNY and USD/CNH impacts the dollar price of Gold, but what drives both of them-and how much-is a black box. We do know that each time Trump raises tariffs on the Chinese, USD/CNY increases to offset them, but by how much exactly is unknown. That goes even more so for XAU/CNY.
Since its trough on August 16th last, the same day as XAU/USD, XAU/CNY's rise has been almost identical to that of XAU/USD. Yet we don't know which one is driving which, and if XAU/CNY is the leader, we have no idea what is driving that.
Even so, the USD/CNH and XAU/CNY are both worth watching, especially the latter given how extreme overbought it is:
- Daily RSI: 74, and negatively divergent
- Weekly RSI: 87.5
- Monthly RSI: 82
Watch for any sign of a reversal.
While there is ample evidence of just how extreme overbought, bullish, and short the Commercials are, until we see a break of support in Gold, the trend is your friend.
Furthermore, this analysis is based on the near-term outlook for Gold. Medium and long term, unless 1167 is broken, this continues to be a buy-the-dips market. Follow the smart money, because Gold and Silver are the new TINA.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.