I preface the analysis I am about to share by saying that Gold is going to new highs later this year, but we are very likely to get a sizeable pullback first. There are several possible routes to those new highs, which I will summarize here, but all end up at the same destination.
Gold has risen parabolically from its low of 1167 back in August. It peaked at 1331 on January 31, when extreme overbought and following clear negative divergence on both MACDs. It fell back to its support yesterday and bounced off of it. Should that parabola hold, you can see where it is headed, back up towards the 2016 high of 1377.
I expect Gold to rise to the 1360s or 1370s, fail to break higher on the first attempt, with a sizeable pullback to follow. Support levels on the downside in Gold should we reach 1377 would be 1297, 1240, and 1220. There is also the 200-day moving average, currently at 1251. A healthy retracement in the MACD Line would provide the base to take us up to new highs.
ELLIOTT WAVE THEORY
There is an alternate route higher. This rally could be wave 1, an impulsive 5-wave rally off the low of 1167 in August, and currently we’re in a corrective wave (4) down of wave 1 from the peak at 1331. Corrective waves are typically ABC corrections, and often the size of the A wave lower matches that of the final C wave. Based on the price action to date, this is one scenario:
These are the recent peaks and troughs in Gold since it peaked at 1331. We could be in wave C, down now having peaked at 1322 on Wednesday. If wave A = wave C, then the bottom should be 1297. If C extends lower, then the next big support level is 1280-75.
From there, we head higher in the 5th and final wave of wave 1 to the 2016 high, fail, and fall back in wave 2 to one of the support levels provided above. Once we establish the low, then we’re off to new highs on the upside in wave 3.
This is just one scenario, but it is the primary one that I am watching right now. The alternate is that we break Wednesday’s high of 1322 and go straight up to the 1360s or 70s before falling back.
My preferred measure of sentiment is the Daily Sentiment Index, or “DSI”. I have found this to be extremely accurate in predicting the peaks and troughs in Gold in particular. Case in point recently was the peak of 80% bullishness on January 31, the day Gold peaked at 1331.
The DSI has fallen back to a low of 63 on Wednesday and will go lower if the price falls further. However, the 21-day moving average shown below in orange clearly shows that the trend is up and could go higher. We could get a higher high in Gold and a negatively divergent peak in the DSI below 80, or the DSI peaks in the 80s or 90s before we head lower. Either way, this supports a further rally in Gold once this short-term reversal is done.
Although the COT positioning data has been delayed by the government shutdown, the most recent being that on January 15, it does provide some interesting information.
Money Managers (aka “Funds”) are the price chasers, so it’s no surprise that they are long again given the rally from 1167 to current levels. They have flipped from a record net short position of 109k contracts on October 9 to net long 50k on December 31 (down to 25k on January 25), a change of 160k contracts—over 30% of open interest—in just fourteen weeks. Of the deltas from low-to-high at the twenty-six major peaks in Gold over the past thirteen years, this was the third largest. Not a bullish signal, but also not surprising given the record short level in October.
However, when comparing their peak long position on December 31 st relative to the positions at the other twenty-six peaks, 50k more or less matched the lowest. To give you some reference, the highest net long position held by the Funds was 273k on July 5, 2016. The average was 160k.
On a percentage of open interest basis, the 50k net long position was just 11%, by far the lowest level for any major peak since 2006. The average is 33%.
Although we don’t have the data for the peak on January 31, given that the Funds were likely holding a much larger long position then, my takeaway from the data is as follows…
The rate of change is extremely high, but that could be explained by the fact that we were coming off a record high net short position. Yet, it does support the view that if we do get up to the 1360s or 70s in price and that rate of change approaches the highest level in the past thirteen years, that Gold will fail to break resistance there and see a sizeable pullback to reset those numbers.
The relatively low net long position being held by the Funds, even taking into account increases heading into the peak on January 31, does support a further rally higher to the 1360s and 70s, and following a pullback thereafter, a move to new highs later this year.
At the risk of being pedantic, Gold was closely correlated with DXY on an inverse basis in the past, but correlations come and go and that has clearly broken down since October. That said, I believe DXY is heading up to a peak at 99 or 101.60, and then down towards 80 thereafter.
From a currency perspective, Gold remains far more closely aligned with XAU/CNY these days and to USD/CNH to a lesser extent.
For the purposes of this article, I want to focus on Gold relative to the 10Y U.S. treasury yield. They have been closely correlated on an inverse basis for some time, but have been holding hands recently. When the 10Y yield falls, Gold rises, and vice-versa when the 10Y yield rises, aside from the spike lower in the 10Y yield at year-end.
So why is the 10Y yield falling? The S&P has been on a tear since the start of the year, and yet bond yields continue to fall. In a world where liquidity is everything and there is a substitution effect between bond and equities, yields tend to rise as stocks rise and fall as stocks fall. That was the case until year-end. But while stocks have shot higher, yields have remained low. Why?
This is particularly strange given the exploding deficits and debt in the U.S., increasing the supply of treasuries. At the same time, foreign central banks are buying less and the Fed is still reducing its balance sheet, thereby reducing demand. Economics 101 says that when supply is rising at the same time demand is falling, prices must fall, which in this case means bond yields should rise. So why aren’t they?
My preferred explanation is the prospect of a return to QE, which boosts both bond and equity prices. The Fed’s recent verbal 180 on monetary policy and frequent mentions of a possible return to QE infinity are boosting both markets. QE would provide liquidity to stocks, as it has done since 2009. At the same time, it creates a new buyer for treasury bonds with unlimited funds, solving the demand-supply conundrum Japan-style. Recent weakness in U.S. economic data doesn’t hurt either.
The problem with this is that there is a glaring contradiction here. The S&P is soaring now the Fed supposedly has its back, but the higher stocks go, the less likely the Fed is to “actually” reverse policy, which means no QE and therefore bond yields should rise. If the market figures this out and bond yields do rise, Gold will likely fall.
Finally, and this is a key point as to why Treasury Bond and Gold prices are rising, I believe they know that a return to QE is inevitable and that they are already pricing it in. Stocks may be too, but the Fed will likely need an excuse to actually reverse policy to rate cuts and QE, and a stock market crash would provide that excuse.
I covered this to a great extent in the previous section, but suffice to say that whatever the rationale is, the Fed is preparing us for a return to QE at some point relatively soon and politicians are considering helicopter money (aka “MMT”) at the same time. Many of the analysts I respect on this matter concur that this will create rampant inflation for a country that cannot suffer a dramatic rise in interest rates or yields to curb prices without risking collapse. This is the perfect environment for Gold, and whether these policies come sooner or later, the more people believe them to be inevitable within the next year or two, the further Gold will rise.
Based on what I am seeing today in the data, the balance of probabilities signal a move in Gold back up to the 1360s and 70s, once we hit bottom here shortly, with the risk of sizeable pullback to follow. Following that pullback, Gold is likely heading to new highs later this year, as the prospect of new stimulus policies from the Fed, global central banks, and governments around the world become increasingly likely and fiat currencies continue to be devalued en masse, especially the dollar.