Last month’s price analysis concluded that the market could have experienced a capitulation. He suggested that the FOMC and GDP could trigger a short squeeze based on the COT report being too bearish. As gold rebounded strongly, it met with strong resistance and more hawkish rhetoric from the Fed. With a significant pullback from recent highs, is gold about to break another low, or is it building support in the former $1750-$1800 range where it was trapped for months?
Resistance and support
Gold has breached the $1800 mark at least 10 times in the past two years, sometimes explosively. Each time, gold eventually runs out of steam and falls below. $1750 has been an even stronger support, with fewer breakouts and smaller moves. $1800 may not be comfortably in the rearview mirror until $2100 is removed. For now, gold is back in the $1750-$1800 consolidation range.
Silver has been more volatile and has fallen off strong support at $22 in May. Even when gold rebounded, silver was unable to muster enough strength to regain momentum.
Outlook: Bearish until $22 is removed
Figure: 1 Gold and Silver Price Action
Daily Moving Averages (DMA)
Gold’s false breakout can be clearly seen below with a large move from the 50 DMA above 200 only to pull back. With the current price ($1763) falling below the 50 DMA ($1782) this week and well below the 200 DMA ($1842), momentum is on the wane.
Figure: 2 gold 50/200 DMA
Silver is similar to gold, with the price ($19.07) also falling back below the 50 ($20.02) and 200 ($22.69) DMA.
Margin rate and open interest
Margin rates on gold are near two-year lows, but that has generated little interest. Open interest is also at its lowest in several years. This suggests that the dry powder is ready to make the next big move back and forth. When open interest gets this low, it usually means the next move is up.
Figure: 4 dollar margin rates on gold
The COTs report shows that silver positioning is still sharp in Managed Money. This is a combination of multi-year lows in gross longs and multi-year highs in gross shorts. This suggests that shorts benefited from lower margin rates. Any increase in margin could create a forced short sell-off.
Figure: 5 Dollar margin rate on silver
Gold miners (Arca Gold Miners Index)
Gold miners have very consistently topped the price of gold in both directions. The recent price jump above $1800 has not been confirmed by miners. The last time gold was above $1800, the miners were much higher. Last week showed another poor performance from miners indicating that there could be more downside ahead for gold in the coming weeks.
Figure: 6 Arca gold miners at the current gold trend
Looking at a long-term horizon shows how much miners have underperformed gold over the past decade. This shows that traders have never confidently bought any momentum in gold, anticipating that price increases will be short-lived. When this trend reverses, gold could start to fly higher, led by a booming mining sector.
Figure: 7 Historical trend of Arca gold miners to gold
Love or hate traders/speculators in the paper futures market, but their impact on prices is impossible to ignore. The charts below show that more activity tends to drive prices higher.
Gold trading volume is near the lowest in years and is expected to rebound. The silver is closer to the average, but the COT report suggests this is likely due to the short side. Until the shorts start to get squeezed into the money, it looks more neutral than bullish.
Bullish Gold and Neutral Silver
Figure: 8 Gold volume and open interest
Figure: 9 Silver volume and open interest
USD and treasury bills
Price action can be driven by activity in the Treasury market or the US dollar exchange rate. A sharp rise in gold will often occur simultaneously with a drop in US debt rates (a rise in Treasury prices) or a decline in the dollar.
Figure: 10 DXY, GLD, 10-Year Price Comparison
The dollar has been on an absolute tear for months now (the orange line above shows the reverse movement). The DXY broke through resistance at $105 and reached $109 in July. After a brief correction, the DXY is rising again with a massive move in the past week. If the DXY breaks through the recent high, it could create more problems in the gold market.
Outlook: bearish if the dollar breaks through
Gold Silver Report
Gold and silver are very strongly correlated, but do not move in perfect harmony. The gold/silver ratio is used by traders to determine the relative value between the two metals. Historically, the ratio has averaged between 40 and 60, so outside of this ban may indicate an upcoming mean reversion.
Silver is definitely outside the band, which means gold will fall or silver will have to catch up.
Outlook: Silver VERY bullish versus gold
Figure: 11 Gold Silver Ratio
Bring it all together
The table below shows an overview of the trends that exist in the charts above. It compares the current values to those of a month, a year and three years ago. It also looks at the 50 and 200 day moving averages. While DMAs are usually only calculated for prices, the DMA on other variables can show where current values stand relative to recent history.
After the recent rebound from oversold conditions, gold and silver are sliding again. The charts above are definitely more bearish, which means caution is in order. That being said, the data could suggest that a bottom is forming, and $1750 proved even more problematic for the bears than $1800 for the bulls.
- Gold open interest is 11.7% lower than last month and 15% lower than the 200 DMA
- 50 DMA gold volume is 7% lower than 200 DMA, suggesting a general lack of interest (August is also generally slow)
- The current gold/silver ratio is 20% higher than a year ago
Figure: 12 Summary table
Gold and silver were extremely oversold last month and saw a mini short squeeze on the heels of the FOMC and GDP meeting. Last month’s analysis hinted at this possibility. Unfortunately, the upside petered out as the market was pricing in more time before a Fed pivot. The path is now much less clear. Gold could be back between $1750 and $1800. Or, a hawkish Fed at the top of Jackson Hole could potentially break through $1750 and open the door to new lows. Gold diggers are definitely anticipating this!
On the other hand, the economy is clearly in recession and the Fed is moving very fast. It will likely be a few more months before they see the initial impact of the damage they inflict, let alone the full impact. The damage in their wake could be catastrophic for the over-indebted US economy. When the damage becomes apparent, the Fed will reverse course very quickly. The Treasury also needs this rapid reversal, otherwise the interest on the debt will soon exceed $500 billion a year.
In the near term, caution is in order until gold can confidently break above $1,800, likely necessitating prices above $1,850 for an extended period. The money is in a similar boat, running out of momentum and needing to recover $22 to then start another run at $25 and even $30.
Long-term investors should not be discouraged by the current metals crisis. The medium term is much more bullish. The Fed has a very short track to bring inflation back below 3%. Each month, this track gets shorter. The faster they move, the more damage they will deal before they even know what happened. A powered pivot is not a matter of “if” but of “when”. As the pivot becomes evident, gold and silver will begin to rise rapidly.
Data source: Futures & Options Trading for Risk Management – CME Group and fmpcloud.io for DXY index data
Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.