A Strong Rebound, but Resistance Not Overcome Yet

Here is a brief summary of the technical backdrop in gold and gold stocks as it evolved last week. A week ago we noted that there was a panic sell-off occurring in gold stocks, a kind of “reverse blow-off” (see: “An Anti-Bubble Blow-Off in the Gold Sector” for details). Initially kicked off by tax loss selling, the weakness in gold stocks began feeding on itself after gold broke below the medium term support level at $1,180 that had held since 2013.

As often happens, the US payrolls report on Friday turned out to be a trigger for a short term reversal in the gold market. Although the report was widely characterized as having “missed expectations”, it should be pointed out that it was by no means a weak jobs report. Quite on the contrary, as Mish points out in his detailed analysis, a closer look at the details reveals that it was actually quite a strong report. The headline number is actually not so important in this context. The salient points are the strong household survey and the fact the the employment population ratio increased for a change. However, there are also weak spots in the report, as once again low-paying job categories seem to have experienced the strongest growth.

 

philharmoniker(Image credit: fmh)

Given that employment is a lagging economic indicator and payroll reports tend to be revised several times, the report as such is actually quite meaningless. The main reason why it often provokes strong short term reactions in financial markets is the Fed’s dual mandate – a superficially weak report is interpreted as evidence that monetary policy will be kept loose for longer. We would argue though that the main reason why gold finally rallied on Friday was simply that the market was severely oversold and too many speculators had begun to lean in the same direction. In short, any excuse would probably have triggered a rally.

The rally has brought the gold price to within a whisker of the above mentioned support level (which now represents resistance). We don’t know if gold will manage to actually overcome this resistance in the near term. However, we can offer an “if-then” suggestion. We previously opined that a break of the 1180 support level was likely, but may not be sustained for long, as bearish sentiment had become quite extreme. If this turns out to be the case – i.e., if the market manages to close at least 3% above this level, preferably on a weekly basis – then it will turn into a “failed breakdown”, which would have bullish implications. However, previous retests of broken support levels have led to renewed selling, so from a technical perspective the jury is still out.

Slightly favorable is the fact that turning points in the sector (both highs and lows) happen quite frequently in the October/November time frame. Also favorable are recent positioning data – the net speculative long position in gold futures has reached its lowest level in many months, with small speculators more bearish than at any time since 2000. Lastly, the HUI index has briefly broken below its major lateral support at the 150 level (for a long term chart showing this support click here) and has subsequently reversed back above it. The initial rally in the index was recorded on Thursday (with gold flat), with strong follow-through buying on Friday. This is a positive indication, especially as trading volume in gold stock ETFs reached one record high after another last week. Note however that even if a durable low has been put in, a retest is likely, although this doesn’t have to happen (a successful retest on lower volume would be very positive though). So there are a few positives in place, but since there can be no assurance that gold will break through resistance, a resumption of the bearish trend cannot be ruled out yet. Below are charts illustrating the situation.

 

1-Gold, dailyGold daily – after Friday’s bounce, it is back at the previously broken medium term support level – click to enlarge.

 

2-HUI, dailyThe HUI index daily – after briefly dropping below the long term support level at 150 which is defined by the 2002-2003 highs and the 2008 lows, the index has rebounded – click to enlarge.

 

3-GDXJ record volumeTrading in GDXJ as an example for the emotional intensity that accompanied the recent sell-off and rebound. On several days, the biggest trading volume in the ETF’s history has been recorded, with volume on occasion of Friday’s rebound especially large – click to enlarge.

 

4-Gold-CoTThe net speculative position in gold futures has recently become quite lopsided – click to enlarge.

 

The discounts to net asset value exhibited by closed end bullion funds have tightened a bit from their recent extremes, but not by much as of yet. There is certainly room for these discounts to come in further, but the fact that they are still very large is not necessarily a good sign – further tightening definitely would be though.

 

A Look at Gold’s Main Antagonist – the US Dollar

One of the main drivers of gold’s recent decline was the strong rally in the US dollar. The rally is mainly based on the idea that while Federal Reserve policy is set to continue to tighten, other central banks are adopting looser monetary policy.

For the time being, US dollar money supply growth remains higher than money supply growth in both the euro area and Japan. However, as Keith Weiner recently remarked, even if the quantity of yen is not (yet) increasing at a very fast pace, the currency’s quality is undoubtedly severely undermined by the BoJ’s “QQE” policy (the acronym even includes the term “qualitative”). We have recently also argued that the BoJ’s policy represents a growing danger for the currency, although we still believe that the yen is likely to rise should the global party in “risk” take a breather.

The euro meanwhile remains a somewhat dubious construct, even though there has been a drive to force the governments of member countries to hew to the new “fiscal compact”. We already see the commitment to this agreement wavering though, with France trying to once again get an exemption, and others increasingly arguing in favor of fiscal “stimulus”. Also, with the sovereign debt crisis in pause mode, the pressure to enact meaningful economic reform has disappeared – hence, there is now more talk about reform than actual reform.

However, all of this is well known by now and should therefore already be reflected in prices. For the dollar to continue to rally, a fresh impetus will be required. Meanwhile, from a technical perspective, the dollar seems ripe for a setback:

 

5-DXYThe dollar index, daily. The dollar has recently resumed its rally, but has produced a glaring divergence with RSI in the process – click to enlarge.

 

Even more noteworthy than this price-RSI divergence are however the positioning data in DXY futures and the message form various sentiment indicators such as sentiment survey data. Currently the combined bullish consensus on the dollar index (several of the most important sentiment surveys combined) stands at 85%, down just 3 points from a recent record high of 88%. Furthermore, in DXY futures the most extensive speculative net long position in the history of the contract was recently recorded – with the small speculator position especially large in a historical context

 

6-DXY-CoTsNet commercial hedger position and small speculator position in DXY futures – both have recently reached a historic extreme – click to enlarge.

 

It should be noted to all this that the strong bullish consensus on the US dollar is certainly understandable – technically, it has overcome a long term resistance level recently, and the fundamental backdrop has certainly been moving in a direction that is favorable to the dollar as well. Carry trades that have employed the dollar as a funding currency are increasingly in trouble, so there is pressure from those as well (and this pressure could still increase further). However, even if the dollar should be set to eventually continue its rally, it is now so overbought and over-loved in the short term that a sizable setback is probably quite close.

 

Conclusion:

It remains to be seen whether gold will be able to regain its broken support level. Until then, a resumption of the decline remains quite possible. Keep in mind that if the support break is sustained, the $1,040-1,050 level will become a price attractor. Cyclical factors, sentiment extremes, the dollar’s overbought status and the reversal of the HUI from just below its long term support level are however currently factors favorable to gold.

Moreover, recent earnings reports from a number of gold producers have shown that the decline in production costs is accelerating as well. For instance, major producer Kinross Gold announced that its all-in sustaining costs have declined from $1,082/ounce a year ago to $919/ounce in the third quarter of the current financial year. Aurico (AUQ) reported a decline of 17% in cash costs quarter-on-quarter last week. Several South African producers (e.g. HMY and DRD) have also reported strong strong declines in production costs recently. This indicates that gold mining margins should at least be maintained, in spite of the weakness in the gold price. Moreover, gold producers will be in a “sweet spot” for a while once the gold price rises again.

 

Addendum:

At the time of writing (about 7 hours before the COMEX open), gold was down a few dollars from Friday’s close, so it remains below the broken support level for the moment. If the level is destined to be regained, it will however very likely anyway happen during COMEX trading hours.

 

7-Gold-30 minute chartGold, 30 minute chart. Last trade approx. as of 0:30 EST – click to enlarge.

 

Charts by: StockCharts, Sentimentrader, Barcharts

 

 

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One Response to “The Gold Situation”

  • RedQueenRace:

    If gold is to head lower, near your 1050 support level is 1088.45, the 50% retrace of the entire bull market from the 1999’s 253.20 low to the 1923.70 high.

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