A New High In Gold Leads To A Significant Correction
Summary
- Risk-off rocket fuel for the yellow metal turns into a dud.
- Gold stops just below the $1700 level and tanks.
- Stocks have the worst week in years.
- Junior gold mining shares follow the yellow metal.
- Time to buy GDXJ on a scale-down basis - the Fed will cut rates.
- Looking for more stock ideas like this one? Get them exclusively at Hecht Commodity Report. Get started today »
The final week of February began with a giant thud in markets, which only got worse as the week progressed. The spread of Coronavirus to South Korea and Italy created panic selling in stocks and commodity markets. The DJIA dropped over 1,000 points on February 24 and continued lower throughout the week. The Coronavirus was a trigger, but the selling created the environment for the plunge that followed. Crude oil, which had been taking the stairs higher from below the $50 level earlier in the month, got back on the elevator to the downside and fell to a new and lower low as it approached the late 2018 bottom by the end of the week. Agricultural commodity prices experienced pressure, and copper fell to the $2.50 per pound level. There was price carnage on the first day of the final week of the second month of 2020, and the days that followed got worse. Risk-off conditions gripped markets across all asset classes. US bonds rallied in a flight to quality. Gold and silver posted gains, initially. The yellow metal rose to almost $1700 per ounce, which was a new high and the highest price in seven years on February 24 before correcting significantly lower.
The bull market in gold began in the early 2000s, but the next leg to the upside started last June. Falling interest rates in the US and around the world lit a bullish fuse under the precious metal that central banks hold as part of their foreign currency reserves. The Fed may have no choice but to take significant action to stimulate in the current environment. The VanEck Vectors Junior Gold Miners ETF product (NYSEARCA:GDXJ) fell like a stone.
Risk-off rocket fuel for the yellow metal turns into a dud
At first, the selling in markets across all asset classes lifted gold. On Monday, February 24, the price of the yellow metal rose to a new and higher high.
Source: CQG
As the daily chart of nearby gold futures highlights, the nearby contract reached a high of $1619.60 on January 8 as tensions flared between the US and Iran. As the situation calmed, the price fell to a low of $1551.10 on February 5, where it ran out of steam on the downside. As the fears over the Coronavirus rose, the price of gold moved higher. On February 20, the yellow metal moved above the January 8 high. On Monday, February 24, the price spiked to $1691.70 in what was a short-term blow-off top. Price momentum and relative strength indicators rose to overbought levels but turned lower as the price collapsed throughout the week. The total number of open long and short positions in the COMEX futures market moved higher from 650,392 contracts on February 5 to 722,120 contracts on February 27. Meanwhile, the metric likely dropped on February 28 as the selling accelerated in the gold futures market taking the price to a low of $1564 per ounce on the Daily historical volatility rose from 6.56% on February 20, the day gold moved to a higher high, to over 27% at the end of last week. The price in the measure of price variance reflects the risk-off conditions gripping markets across all asset classes.
The bottom line is that risk-off was initially another tank of rocket fuel for the bull market in gold, but it failed and moved lower in sympathy with markets across all asset classes throughout the week.
Gold stops just below the $1700 level and tanks
The last time we saw the price of gold above the $1700 per ounce level was in December 2012.
Source: CQG
The quarterly chart of COMEX gold futures illustrates the continuation of bull market price action since the yellow metal broke out to the upside in June 2019 when it rose above critical technical resistance at $1377.50 per ounce. While $1700 is a psychological level in the gold market, above there, the next technical target will be between $1785 and $1805, the peaks from the final quarter in 2011 and 2012. That band stands as a gateway to the all-time high at $1920.70 and new highs in gold. When it comes to technical indicators, price momentum and relative strength have risen into overbought territory. However, the metrics can remain in an overbought condition for a prolonged period, as we witnessed from 2004 through 2011.
Gold has reached new record levels in almost all currencies around the world except for the US dollar and Swiss franc. However, the current trend continued to tell us that the next shoe to drop will be a new peak in the franc and new highs in US dollar terms.
As of the end of last week, gold rejected $1700 level and suffered a correction. The price action in the stock market suggests that the Fed will need to provide stimulus, and that could be another tank full of fuel for the bull market in gold.
Stocks have the worst week in years
The stock market turned ugly during the final week of February 2020. Market participants had not experienced the level of risk-off price action since the last quarter of 2018 when rising US interest rates weighed on stocks and markets across most asset classes.
Source: CQG
The weekly chart of the E-Mini S&P 500 futures contract shows that the selloff that caused implosive price action last week was the most significant move in years.
While Coronavirus accounts for some of the risk-off behavior, the rise of support for Senator Bernie Sanders in the opposition party in the US could be adding to the price pressure. The stock market thrived in an environment of corporate tax and regulatory reforms under the Trump Administration. Senator Sanders is an advocate for Democratic Socialism, which could have significant ramifications for taxes, regulations, and many other policy initiatives. Wall Street is not a fan of the Senator from Vermont, and that is OK with him as he is no fan of big business. The notion of a billionaire is a curse word to the leader of the progressive movement in the United States. The significant downdraft in the stock market came as the Coronavirus spread from China to other countries around the world, but it also came as Sanders won the Nevada caucus and emerged as the leading candidate to capture the nomination of his party to challenge President Trump in November.
Last weekend, South Carolina held its primary, and March 3 is Super Tuesday, which will cull the herd of candidates. If Senator Sanders continues to win primaries, he would establish a dominant position going into the convention. As an advocate for a significant shift in the US political system from capitalism to socialism, the impact on the stock market and markets across all asset classes could be dramatic. At the same time, any fear and uncertainty created by Sander's rise to the top of his party could undermine the incumbent President, who will run on the strong economy and stock market. A substantial decline in stocks under President Trump's watch could strengthen Senator Sander's chances of victory in November.
At the same time, the US central bank is likely to act to stem the carnage in markets. We should expect a continuation of wild price action in markets across all asset classes. I would view a significant bout of central bank accommodation as a bullish factor for the price of gold.
Junior gold mining shares follow the yellow metal
Junior gold mining faced a falling stock market and the rising gold market at the start of last week. The VanEck Vectors Junior Gold Miners ETF product holds shares in a diversified portfolio of junior mining companies that mitigates some of the idiosyncratic risks of holding individual junior mining shares. The price of COMEX April gold futures rose from $1551.10 on February 5 to $1691.70 on February 24, a rise of 9.1%. The price then dropped to settle at the end of last week at $1566.7, 7.4% lower on the week. Over the same period, the GDXJ product did better on a percentage basis on the upside and worse on the downside.
Source: Barchart
The chart shows that the GDXJ moved from $39.80 to $46.42 per share or 16.6% over the same period. As of the end of last week, the price of April gold was at the $1566.70 level, 7.4% below the high. GDXJ fell to $35.43 per share or 23.7%. GDXJ provides market participants with a leveraged position in gold as the volatile gold mining shares tend to outperform on the upside and underperform when the price of gold declines.
Time to buy GDXJ on a scale-down basis - the Fed will cut rates
Citigroup analysts recently forecasted that the price of gold would rise above the $2000 per ounce level over the coming twelve to twenty-four months. Gold had already reached new highs in most other currencies.
During periods of price weakness and corrections in the gold market, as we witnessed last week, I favor buying the VanEck Vectors Junior Gold Miners ETF product on a scale-down basis. The top holdings of GDXJ include:
Source: Barchart
GDXJ has net assets of $4.89 billion, trades an average of over 15 million shares each day, and charges a 0.54% expense ratio.
Gold made a new high last week at just under the $1700 per ounce level. While the yellow metal backed off, the price tanked by the end of the week sending GDXJ substantially lower. The price action in markets across all asset classes is likely to cause the Fed to act and slash interest rates. We could see a return of quantitative easing in the current environment. We have learned that accommodative central bank policy is rocket fuel for the gold market. If that trend holds, buying GDXJ on a scale-down basis may turn out to be a leveraged approach to an investment in the yellow metal. I would leave plenty of room to add to a long position in GDXJ on further price weakness given the extreme level of volatility in all markets. Be careful out there.
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This article was written by
Andrew Hecht is a 35-year Wall Street veteran covering commodities and precious metals.
He runs the investing group The Hecht Commodity Report, one of the most comprehensive commodities services available. It covers the market movements of 20 different commodities and provides bullish, bearish and neutral calls; directional trading recommendations, and actionable ideas for traders. Learn more.Analyst’s 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.
The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.
The author is long gold
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Comments (52)
" I see that major grocery chains are preparing should there be a run on stock...if I had a few gold coins I guarantee you I would sell those coins for food"
Well for myself I would just use some Silver ,unless I was buying truckloads of food :)
@jadejet @OlderThanDirtDave
@Investor since ‘73
I continue to believe that gold is a wise investment in a period of excessive debt, particularly in a period of unusually low rates where risk is often mispriced. For those who don't have gold, this looks like a good buying opportunity if you are a long term investor.
