Gold and silver had bang up weeks. Gold closed yesterday afternoon on a cash basis above $1900, at $1901.95 just $18 shy of the all-time high set in September 2011 at $1920.
Silver, which has famously lagged behind gold for two years now, finally broke through the post-Brexit vote high of $21.13 (again cash basis) on Monday and never looked back, exploding above $23 to close this week at $22.77 an ounce.
The weekly prints weren’t even completed yet when I start seeing the calls in my inbox saying they are incredibly overbought. It’s an easy position to take into a breakout because of indicators like 200 day moving averages and Bollinger bands, because these this indicators are all about mean reversion strategies.
And, yes, markets always revert to the mean. But they also stay irrational far longer than you can stay solvent. This is especially true when central banks around the world pump trillions into the markets to keep them from collapsing.
Markets don’t trade on fundamentals or statistical regressions of the past.
Markets are forward-looking.
They trade on momentum and sentiment.
Instead of piling on some, frankly, superficial technical analysis about how silver is now X% above its 200dma and that means it’s overbought, the question one should be asking is, “What in the holy hell is going on here?”
I think there are a number of factors at play that have all lined up to answer that question.
The first is the most important, which I’ll focus on.
This week’s proximate cause was the breakdown of the U.S. dollar index (USDX) because of the shift in the political and fiscal structure of the European Union.
The USDX had been plumbing recent lows as the markets bought into a reflation trade surrounding the end of the COVID-19 lockdown around the world.
Gradually, all that money that was stuffed into the hands of the banks, the hedge funds and Blackrock as the U.S. treasury’s agent bid asset prices higher, honestly, across the board, with the exception of oil.
U.S. bond yields are at historic lows, stocks historic highs, gold now within $20 of its all-time high. But, what drove the USDX to new lows?
Why was the U.S. dollar the only thing seemingly on sale?
The sharp rise in the euro thanks to a successful European budget and COVID-19 crisis summit, the outcome of which, by the way, was never in doubt.
Because currency traders are now betting the farm — or at least signaling that they want to — that the European Union will now become a proper political and fiscal entity since the European Commission now has both taxing and spending authority directly.
This has been the thing the markets have been punishing the euro for for years. And now the process has begun.
The euro blew through the March high when capital flew out of U.S. assets for a short time to quell European bank solvency fears and then promptly rushed right back out the minute the worst of the crisis ended.
You look at this weekly chart of the euro and tell me markets give a rat’s ass about 200 day moving averages in a crisis (shaded area of extreme volatility)?
It’s clear from the chart that the March low in the euro was significant and a new weekly closing high is far more important than how far away it is from its historical average.
I was unconvinced in this rally in the euro until last week when the euro close strong for the first time above $1.13 (orange line, see chart). It had failed to convince traders going into a weekend they wanted to be long the euro, regardless of where it stood versus the long term.
Why this is important for gold is that gold has been trapped between two opposing forces for nearly a year now.
On the one hand is the safe haven trade that’s been in place since last year’s seizure of the repo markets in September — moving in concert with a strong dollar.
On the other is the reflation trade, relying on the kindness of central banks creating liquidity and positive market sentiment. This would cause the dollar to drop alongside gold as traders ran with the ‘happy days are here again’ trade.
All along gold was slowly grinding higher regardless of the dollar, and that told us there was a sentiment change underway. But, day-to-day, week-to-week, gold was trapped between these two trades, broadly.
But the spasm in March changed that dynamic as the dollar markets seized up and the world went into ‘sell everything not dollars’ mode. Gold always gets hit on those days and, in general, that’s where the most violent downdrafts in gold occur.
But, as I said, overall gold has been grinding higher as bulls kept supporting the price on pullbacks at higher levels. Because once gold broke above the post-Brexit high of $1375 last summer, it was now officially, technically in a bull market, having broken out of a six-year consolidation pattern on the quarterly chart.
Closing prices matter. And June’s strong close in gold told everyone that something had fundamentally changed. Look at the Q1 bar. Note how it closed above the Q3 2019 bar despite the markets locking up in early March.
That’s a very powerful signal. And it more than set the stage for the run we’ve seen for the past four months. With the huge move in Q2 gold should have sold off into the close on profit taking and book squaring.
It didn’t. In fact the shorts got killed and still are.
And that signals that the dynamic between the USDX and gold has been broken, at least for the time being. Gold is now trading independently of all other currencies, including the dollar.
Moving averages cannot capture pent up market energy like simply reading the candlesticks can. There is more predictive power in understanding the relationship of one bar to another and relating those change through time.
All of the things I just discussed in terms of gold’s quarterly performance were setup in the weekly and monthly charts at key moments in time. This is why I do twice weekly video Market Reports for my Patrons who benefit from seeing these strategic markets evolve on a regular basis.
Time and price are far more important than statistics. All statistics can do is give you pot odds of a move higher or lower. And right now, for the month of July, is gold overbought?
So the odds for the rest of July state gold will see it’s all-time high at $1920 and run back into its burrow for a few weeks. It’s been a good run, but that high from September 2011 is historic and it should be respected by both bulls and bears.
But that’s the easy call. What’s far more important now is how gold closes this month. Because that sets up the probability of what it should do in August.
Because if gold were to close July where it closed this week, $1901.15, versus a high of $1906.68 and a low of $1757.71 then there is a 90% chance of gold breaking July’s high and just a 1.2% chance of gold breaking the July low.
And given that in any single month gold, on average, moves $80 and the difference between closing prices is $63, there is a excellent chance that breaking the July high in August will also create a new all-time high.
Those are the odds. There’s no arguing with the numbers. Being long gold here, despite the apparent frothiness is the right play. Until I see a weekly close that alters that picture, throwing some form of reversal signal which violates a previous low, gold is a buy right now.
Of course, at this level I’m looking for that signal to show up this week, the last week of July, to push the price back and alter the odds for August. It’s been the history of both gold and silver to get crushed into the monthly and quarterly closes to keep its momentum muted.
Silver’s position is even more interesting because silver is now two years behind gold in terms of the big picture (quarterly chart breakout) and hasn’t even had a chance to run before people are calling for it to collapse.
This week was the one where silver finally bested the post-Brexit high of $21.25 an ounce. It was set up by to huge weekly closes which pushed through near-term resistance above $18.00. Last week’s close at $19.32 was met with massive follow-through buying which pushed the price through what should have been stronger resistance above $20 which literally didn’t matter.
Look at the shaded area on the chart. That is a seven-year consolidation below $21 per ounce. A July close above that level sets up a move to the $26 area, the area that was support after the 2011 peak (see chart).
And you can see that silver is way beyond its normal trading behavior but coming off the strong June close there were 9.5:1 odds that silver would break the Q2 high in Q3 and use that as energy to challenge first the Q1 high and then the 2016 high. That it did all of these things in three weeks should tell you just how strong bullish sentiment is and how pent up the demand for silver was.
And because silver lagged gold all year, gold could easily flame out alongside stocks well before silver does. In fact, that’s my medium-term call.
Because silver isn’t as much a monetary metal nor is it a safe-haven asset like gold. So it could be telling us something is changing in the strategic metals complex which should scare all the ‘v-shaped’ recovery punters on CNBC.
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