Tentative Signs of Life in Gold - David Brady (12/10/2018)

Oct 12, 2018

Gold has finally caught a bid this week and is up to its highest level since July 31. The fact that the U.S. and China appear to have agreed on a meeting between Trump and Xi on trade issues at the next G20, coupled with the U.S. treasury’s decision not to label China a currency manipulator, was likely the biggest factor in Gold’s rise yesterday. It may be seeing some safe haven flows due to the precipitous decline in stocks the past couple of days. There is also the possibility that Gold is anticipating a reversal in the Fed’s tightening policies and a weaker dollar due to a potential crash in stocks. If so, then the bottom is likely in place and a historic rally in Gold has begun. But I wouldn’t break out the champagne just yet.

Stock market crashes by definition are deflationary. Almost all of the soft and hard commodities are down in the past couple of days at the same time stocks dumped: Oil, NatGas, Copper, Wheat, Coffee, Cocoa, and Sugar, to name a few. These are all priced in dollar terms, so if the dollar is expected to weaken, they should rise. On the contrary, they are falling due to expectations of weaker demand and possibly recession, which one would expect to follow a crash in stocks. They are clearly not expecting a Fed reversal in policy yet. Are Goldbugs smarter in that they do foresee a Fed policy reversal? Perhaps, or this bounce in Gold is solely due to a weaker USD/CNY and higher XAU/CNY in response to a thawing of relations between the U.S. and China.

This is important for two reasons. If stocks continue to plummet, and I expect they will (in February this year, I forecast a rise to new all-time-highs in the S&P before a crash in the Fall to ~2100), this is more likely to be a drag on Gold than a benefit, until the likelihood of Fed reversal in policy becomes more transparent. This means that the primary reason for Gold’s rally is the recent positive change in tone with respect to the U.S.-China trade war. But how sustainable is that? Has the good news already been priced in until the G20 occurs? That is not until November 30. If so, and stocks continue to plummet, this rally may be short-lived before we head down to lower lows.

I would also not be surprised if U.S.-China talks at the next G20 produce little or nothing yet again, given that they are scheduled to occur post the Midterm elections. Such an outcome could send USD/CNY higher and Gold lower once more.

Gold certainly had the ammunition for a major rally, thanks to record shorts, oversold technicals, and extreme bearish sentiment, but all have improved recently, and Gold is already back to an RSI of 62 on its daily chart. Alternatively, this could be a dead cat bounce before lower again. There is significant resistance ahead that could stall Gold’s rally, most notably 1244, the 38.2% Fibonacci retracement of the entire drop from 1369 to 1167, and 1251 on a closing basis (1360-1184). If we close above the latter, then the bottom is likely in place and a truly historic rally has begun. There is plenty of upside from there.

Suffice to say, it is refreshing to see Gold finally pull itself up from the floor. It is human nature to get excited by the prospect of bigger gains ahead after such a long dump since April, but I suggest caution until we see either a Fed reversal in policy and, more importantly, a peak and sustainable fall in USD/CNY.