Bad Hair Day Produces Positive Divergences

On Friday the ongoing trade dispute between the US and China was apparently escalated by a notch to the next level, at least verbally. The Trump administration announced a list of tariffs that are supposed to come into force in three week’s time and China clicked back by announcing retaliatory action. In effect, the US government said: take that China, we will now really hurt our own consumers!  – and China’s mandarins replied: just you wait, we can hurt our consumers just as badly!


Left: the US administration releases details of its upcoming domestic consumer mistreatment measures; Right: China immediately shoots back with an image of the infamous ankle crusher which it plans to unleash on its own population in retaliation.


It’s all very sensible – after all, who needs trade? It is well known that mountain caves cut off from all contact with the outside world are the richest places on earth… no, wait. Anyway, ostensibly commodity futures traders took the news as a reason to sell. We don’t really believe it, since they were presented with the same “reason” an estimated umpteen times already and didn’t sell on those previous occasions. Nevertheless, commodities were sold – and the real reason is probably that global growth is turning down quite fast, with leading indicators outside the US recently entering contraction territory.

Gold sold off in sympathy, presumably because precious metals with a significant industrial demand component such as silver and the platinum group metals were hit quite hard. It doesn’t really make a lot of sense, but it should be noted that the relationship between gold and commodities is characterized by ambiguities. They often trend in the same direction – particularly when the USD is weakening –  but the economic conditions (or the state of economic confidence) that is bearish for commodities is actually bullish for gold and vice versa. It is ironic that gold has withstood a bearish fundamental backdrop for quite some time and is now actually selling off on developments that would normally be considered bullish rather than bearish.

Whatever the reasons for the selling, we prefer watching for technical clues, since  we can never know with certainty which underlying fundamental drivers will be assigned the greatest weight by market participants. The gold market continues to look intriguing on that basis – this seems a good time to pay attention and prepare for a potential trend change. The reason is that a number of potentially positive divergences are beginning to show up (while the highs earlier this year were marked by bearish divergences).


The chart above compares the gold price in USD to the HUI Index and gold priced in euro. The red dotted lines indicate the large bearish divergences put in after the seasonal rally beginning in December, the blue dotted lines indicate the bullish divergences which have emerged recently.


Obviously, divergences can always be erased – but the larger they are, the less likely that becomes. “Large” refers both to their extent and the amount of time consumed in creating them. The most recent divergences and signals are not firmly established yet, but they have potential, which is why we point them out. Readers may remember that we inter alia wrote about a certain “canary in the gold mine” in late 2015 (also a good time to pay attention to the sector). An analogous development seems to be underway at present:


The stocks of South African gold mining companies which derive the bulk of their earnings from domestic operations are quite a useful early warning indicator near meaningful lows. Note that “near” sometimes means that one still has to be patient for months – but the lead time is by no means fixed. Here we compare moves in the Rand gold price to DRD (which generates its entire income in SA) and the HUI Index – note what happened in late 2015 and what has begun to happen recently. We should not necessarily expect an exact replay of the 2015 pattern (or the 2001/2002 pattern for that matter), but this is definitely a signal with strong potential.


In case you are wondering why we show DRD but not HMY, the latter is currently subject to company-specific developments which are weighing on its stock price  – namely a share placement to fund the recent Moab Khotsong acquisition. Amazingly the stock has sold off for the second time on the same news, despite the fact that the placement was only half as big as originally feared. HMY lagged in 2015 as well, but it eventually followed the lead of DRD and not only caught up with it, but quickly overtook it (the gold price leverage of HMY is even more pronounced).

Similar to the divergences shown in the first chart, one has to keep in mind that the Rand gold price-related signal is quite recent and not fully developed yet. In other words, follow-through is needed, which would be provided by the Rand gold price exceeding its late 2017 peak near ~ZAR 18,600 per ounce, preferably confirmed by the prices of SA-based gold stocks.

There is actually a good reason why the Rand gold price and SA gold stocks fairly often lead the USD gold price and the HUI near major lows: rate hike campaigns by the Fed often affect emerging market economies before they affect the US economy. This is especially relevant for developing countries that have incurred a lot of dollar-denominated debt and/or are sporting large current account deficits. Significant pressure on the most vulnerable EM currencies and risk assets tends to emerge regularly in these situations.

This time the Argentine peso and the Turkish lira have been hit the hardest  (incidentally the Argentine currency was in focus at the turn of the millennium as well). The problem for investors is that most EM currencies are not particularly liquid and are often subject to sizable central bank intervention and various restrictions designed to fend off “evil speculators”.

The Rand is a laudable exception, as the South African central bank deliberately eschews intervention in foreign exchange markets. As a result the Rand has much better liquidity than most other EM currencies – which makes it an attractive indirect hedging instrument when the latter come under pressure. Hence accelerating weakness in the Rand will often develop as crisis conditions in the EM space intensify.

However, this is invariably also the prelude to a trend change in the US dollar. The same liquidity squeeze that affects emerging markets will eventually hit the US economy with a lag, which in turn will prompt the Fed to reverse course. The gold price in USD terms usually turns up in advance of the associated peak in the dollar index. This is in a nutshell the reasoning behind the idea that the sub-sector of South African gold mining stocks is useful as a leading indicator for the sector as a whole.

Keep in mind the caveat that what has worked in the past won’t necessarily work in the future – but in this case we can point to several historical examples at important junctures and the idea is underpinned by what we think is fairly sound reasoning.


Seasonal Trends May Be Helpful This Time

The 30-year seasonal chart also suggests that it is time to pay close attention to the gold market. As it happens, the seasonal mid-year low is on June 13 (the high of the subsequent seasonally strong period is on November 18). It should be pointed out that the seasonally strong period has produced positive returns in just 60% of the cases over the past three decades (in USD terms).

In the recent gold bear market the results were particularly disappointing, with negative returns seen in four consecutive years (2013 – 2016). 2017 was the first year since 2012 when a positive return was recorded again. Nevertheless, the returns in positive years were so large that a quite respectable annualized return of 8.42% was achieved on average. Given the unusual 4-year streak of negative returns prior to 2017 it may actually be time for an offsetting streak of positive returns (note that in the past the seasonally strong period frequently generated positive returns even in bear markets).


Gold, 30-year seasonal chart (made with the Seasonax app on Bloomberg). The statistics all refer to the seasonally strong period highlighted in red. Obviously seasonal gains are more likely to be seen in bull markets than in bear markets, but there were notable exceptions such as the late 1980s and late 1990s when the period was profitable in bear market conditions as well. The average annualized return is sizable and beats the return made in the rest of the time handily (negative -0.20% annualized). Long negative streaks are often followed by long positive streaks.


We don’t know yet how this year will turn out, but we have noticed that the gold sector quite often bottoms either in the May/June time window, or failing that, close to the time of the seasonal peak in November – December (an example of cycle inversion – this happened last in 2016, when the annual high occurred in late July, 6 weeks after the usual seasonal low. The rally had started around 6 weeks after the usual seasonal peak). Note that this also refers to long term tendencies – it certainly doesn’t work that way every year.

Luckily there is little risk involved with betting on a positive outcome. The recent low in the HUI at around 169 points is only ~nine points below its current level – by using this low as a stop loss level, one can keep risk at a minimum. Keep in mind that well-defined support levels are sometimes subject to false breaks, such as the one seen in January of 2016.

If one is booted out of a position due to a false break one has to be prepared to immediately reenter the market once this becomes obvious, as false breaks are particularly bullish signals (as evidenced by the 180% surge following the early 2016 break). In short, the sector has to be approached with a mixture of patience, discipline and flexibility.

Unfortunately false starts are a lot more common than false breaks, but we believe focusing on the gold sector on junctures such as the current one is worth the effort, as very few market sectors are capable of delivering comparable returns in such compressed time frames. This is a function of the sector’s small size and high leverage to the gold price, which magnify the boom-bust cycles associated with it.


Our luckless gold bug mascot is no stranger to false starts – but better times may be on the way.


Charts by: StockCharts, Seasonax




Emigrate While You Can... Learn More




Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.


Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA


Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • Pushing Past the Breaking Point
      Schemes and Shams Man’s willful determination to resist the natural order are in vain.  Still, he pushes onward, always grasping for the big breakthrough. The allure of something for nothing is too enticing to pass up.   From the “displays of disbelief, revealing touching old-fashioned notions” file... [PT]   Systems of elaborate folly have been erected with the most impossible of promises.  That prosperity can be attained without labor.  That benefits...
  • The Myth of Capitalism - A Book by Jonathan Tepper
      Crony Capitalism vs. Free Markets Many of our readers are probably aware of the excellent work our friend Jonathan Tepper does for Variant Perception (VP)*****, a financial research boutique that really does bring a unique perspective to the table*. Jonathan (with co-author Denise Hearn) has just added a new book to his résumé, which is going to be released on 12 November: The Myth of Capitalism (MoC) – Monopolies and the Death of Competition** (a link to the official site is at the...
  • Three Cheers for James Riley!
      Going All In All people, of both good and questionable character, share a singular talent.  They excel at taking something that’s tolerable in moderation, and then pushing it to the outer limits of absurdity.  Why live with restraint when you can get radical?   A fairly famous stretch of LA riverbed graffiti... [PT] Photo credit: saber   Public and private debt levels, NASDAQ stock valuations, the federal register, face tattoos, canned energy drinks.  You name...
  • Crumbling Piles of Sand
      Just a Little Avalanche or an Implosion? A few years ago, we briefly discussed the dynamics of sand piles in these pages, which are a special field of study in mathematics and physics (mathematically inclined readers can take a look at two papers on the subject here:”Driving Sandpiles to Criticality and Beyond “ (PDF) and  'Games on Line Graphs and Sand Piles “(PDF) – unfortunately two other studies that used to be available have in the meantime disappeared from the...
  • When Fake Money Becomes Scarce
      Remaining Focused A rousing display of diversions this week assured the American populace was looking every which way but right under its collective nose.  Midterm elections.  White House spats with purveyors of fake news.  The forced resignation of Attorney General Sessions...   Old drug warrior (otherwise recused) on his way home to Alabama...   Sideshows like these, and many more, offered near limitless opportunities to focus on matters of insignificance.  Why...
  • Fun and Profit - Precious Metals Supply and Demand
      While Not Saving The Planet, Let Us At Least Have A Good Time The price of gold went up seven bucks, and that of silver rose eight pennies. For many people, the attraction to gold and silver began with a desire to protect themselves from the monetary train wreck of 2008. That often grew into a sense that gold is the solution to that problem.   The post 2008 GFC monetary train wreck: US true broad money supply is expanded by more than 153% in a mere decade, as the Fed takes...
  • Wizard’s First Rule – Precious Metals Supply and Demand
      The Last to Go Terry Goodkind wrote an epic fantasy series. The first book in the series is entitled Wizard’s First Rule. We recommend the book highly, if you’re into that sort of thing.   An image from the title page of Terry Goodkind's best-selling fantasy epic “Wizard's First Rule”. We'd be at bit wary of standing around on that stone-slab bridge to be honest. [PT]   However, for purposes of this essay, the important part is the rule...
  • US Stock Market - Re-Coupling with a Panic Cycle?
      The Mighty Gartman Investment newsletter writer Dennis Gartman (a.k.a. “the Commodities King”) has been a target of ridicule at Zerohedge for a long time. His pompous style of writing and his uncanny ability to frequently make perfectly mistimed short term market calls have made him an easy target.* It would be quite ironic if a so far quite good recommendation he made last week were to turn into the call of a lifetime (see ZH: “Gartman: 'We Are Officially Recommending Shorting...
  • Roger Barris for Congress!
      Economic Man Threatens to Leave You Alone if Elected This one is mainly for readers residing in that glorious water source for California commonly known as Colorado. In case you are not aware of it yet, Roger “Economic Man” Barris, an occasional contributor to this site, is running for Congress in Colorado on a Libertarian Party ticket. We will briefly explain why you should vote for Roger, but first two pictures:   Roger Barris, Libertarian Party candidate for the House...
  • It's Not That Day Just Yet - Precious Metals Supply and Demand
      Degrees of Urgency Monday was Veterans Day, a bank holiday in the US. The prices of gold and silver dropped $23 and $0.61 respectively. “But isn’t gold supposed to go up when...?”   Warren Buffet and Aragorn discuss what to do with the gold. Aragorn wants it, because he knows that even if it's not today, “that day” will come. [PT]   Why? Because everyone else will bid it up. Why? Because they expect someone else to bid it up. Why? Warren Buffet is...
  • Revisiting the Halloween Effect
      From Crash Danger to End-of-the-Year Ramp   [Ed note by PT: we are unfortunately a week late in posting this issue of SI, which didn't reach us in time due to a technical problem. We decided to post it belatedly anyway: for one thing, the effect under discussion is normally in effect until the end of the year; for another, the statistical validity of this information goes beyond the current year, as it is a recurring phenomenon. Lastly we would note that we have a strong...

Support Acting Man

Item Guides

Austrian Theory and Investment


The Review Insider


Dog Blow


THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts


Gold in USD:

[Most Recent Quotes from]



Gold in EUR:

[Most Recent Quotes from]



Silver in USD:

[Most Recent Quotes from]



Platinum in USD:

[Most Recent Quotes from]



USD - Index:

[Most Recent USD from]


Mish Talk

Buy Silver Now!
Buy Gold Now!