Disappointment In The Gold Market

May 23, 2019

Summary

  • A move to over $1,300 fails.
  • The dollar steps on the rally with a bullish reversal last week.
  • Issues around the world warn not to get too bearish.
  • Technical levels to watch in gold on the up and the downside.
  • Gold mining stocks are waiting for gold to make a move - GDX is likely to outperform gold if the price breaks higher.

Gold is a safe haven asset that market participants tend to flock to during periods of fear, uncertainty, and inflation. The yellow metal is both a commodity and a financial asset, making it unique. Along with its many industrial and ornamental uses, gold serves as an asset for countries around the world that hold the metal as part of their foreign currency reserves. Not only do central banks, governments, and monetary authorities hold gold, but they have been net buyers of the precious metal over the past few years. China and Russia are both absorbing their domestic production and purchasing the metal in the international market to build reserves.

Gold has a long history as a currency or means of exchange. Long before the dollar, euro, yen, pound, Swiss franc, yuan, or any other legal tender in circulation today existed, the yellow metal served as a tool for the exchange of goods.

Gold mining companies explore for and extract the metal from the crust of the earth. The VanEck Vectors Gold Miners ETF (GDX) holds shares in many of the world’s leading gold mining companies and tends to outperform the price action in the gold market during bull market periods.

A move to over $1,300 fails

In the wake of the escalation of the trade dispute between the US and China that caused new tariffs from the US on May 10 and retaliation from China on May 13, volatility rose in markets, and gold made an attempt to climb through the $1,300 level.

Source: CQG

As the daily chart highlights, June gold futures put in a bullish reversal trading pattern on May 13 and moved to a marginal new high on May 14 at $1,304.20 before it turned lower. The high for gold in the June futures contract for 2019 was at $1,356, and the low was at $1,267.30 on May 2. On Wednesday, May 22, the yellow metal was trading at $1,275, a lot closer to the low for this year than the high.

Technical metrics turned bearish after the price failure at above the $1,300 level with both price momentum and relative strength metrics moving from slightly overbought toward oversold territory. Daily historical volatility has risen from 6.27% at the start of this month to 8.44%. The total number of open long and short positions in COMEX gold futures rose from 433,874 contracts on May 1 to 524,355 contracts on May 15. It's was at 508,643 on May 21 and it's likely that the open interest metric will decline as disappointed longs throw in the towel on their risk positions as the price of gold moved back below $1,280 per ounce.

The dollar steps on the rally with a bullish reversal last week

One of the leading reasons why gold came down was last week’s action in the dollar, which tends to have an inverse price relationship with the yellow metal. The dollar index hit a new high for 2019 in April at 98.085. After a brief and shallow correction that took the index to a low at 96.81 last week, the dollar put in a bullish formation on the weekly chart.

Source: CQG

The dollar index fell to 96.81 on May 13, the same day gold moved over the $1,300 level. However, the dollar index put in a bullish reversal pattern on the weekly chart as of last Friday, which could lead to higher highs and a challenge of the April peak at just over the 98 level. The reversal in the US currency and potential for a stronger dollar weighed on the price of gold and sent it back toward its low for this year.

Issues around the world warn not to get too bearish

The trade dispute between the US and China is ongoing and is likely one of the reasons for the rise in the dollar. China has the world’s second-leading GDP, and new tariffs and retaliatory moves are weighing on its economy. To stimulate conditions in China, the government is slashing interest rates and devaluing its currency, the yuan. A weaker yuan is a supportive factor for the dollar. Presidents Trump and Xi will meet at the G20 meeting in Japan at the end of June to discuss the current status of trade negotiations. The next significant news on the issues that divide the two nations is likely to come from that meeting.

Meanwhile, the situation in the Middle East is tense with increased US sanctions on Iran and a handful of provocations from the Iranians against oil tankers in the region and a Saudi pipeline near Riyadh, Saudi Arabia, last week. Rising tensions in the area is keeping the bid under the crude oil market and could cause a flight to gold if the situation deteriorates over the coming days and weeks. The OPEC meeting in late June could provide some surprises that may impact markets given the situation with Iran and the ongoing proxy war between the Saudis and the theocracy in Teheran.

Recently, North Korea has begun testing missiles and rockets after the summit between President Trump and Chairman Kim Jong Un did not produce progress and both sides left after the North Koreans refused to take steps toward denuclearization. The temperature on the Korean Peninsula could rise if the hermit nation continues to provoke the US with missile tests in the region.

The European economy remains sluggish, and it's likely Prime Minister May’s last day is on the horizon. The PM will bring another proposal for Brexit, the third, before the House of Commons in June. While it's likely that it will not pass muster with the MPs, this time, the odds favor a resignation from Prime Minister May which will create uncertainty about the leadership of the UK with the next deadline for a Brexit deal looming at the end of October and the potential for another referendum on the horizon.

In the US, political divisiveness seems to reach a new level each day. With the 2020 presidential contest on the horizon, and the desire to impeach President Trump rising among the members of the opposition party in the Congress, uncertainty in the US could cause a flight to safety in markets in the months ahead.

With all of these issues and more facing the world, it may be too early to get overly negative about the prospects for the price of gold despite the strength in the dollar.

Source: CQG

The chart of the US 30-Year Treasury bond shows that after reaching a low at 136-16 during the week of Oct. 8, bonds have been making higher lows and higher highs and interest rates have been stable to falling in the US. The long bond has risen to almost the 150 level on the June futures contract. Falling interest rates are typically supportive of the price of gold and other commodities as they decrease the cost of carrying inventories and long positions. In the gold market, lower rates cause the contango to decline, which often makes gold a more attractive investment option.

Technical levels to watch in gold on the up and downside

The continuous futures contract for COMEX gold shows that a bearish price pattern is emerging, but while the price has made lower highs since 2016, it has made higher lows since late 2015.

Source: CQG

The weekly chart shows that the first level of support on the downside is currently at the 2019 low at $1,266 per ounce. Below there, the 2018 bottom at $1,161.40 is the next level of technical support with the December 2015 low at $1,046.20 the critical line of sand on the downside for the yellow metal.

On the upside, gold’s high so far in 2019 has been at $1,344 per ounce. In 2018, the gold futures market put in a double top in January and April at $1,365.40. In 2017, the high was lower than in 2018 at $1,358.50, but in 2016, gold reached a high at $1,377.50 per ounce following the Brexit referendum which stands at the line in the sand on the upside for the precious metal. With long-term support at $1,046.20 and resistance at $1,377.50, the midpoint is at $1,211.85 per ounce, and the price of gold remains above that level at $1,275 on May 22.

Gold mining stocks are waiting for gold to make a move - GDX is likely to outperform gold if the price breaks higher

Gold failed at the $1,300 level last week as the strong dollar weighed on the price of the precious metal. While there are more than a few reasons why the dollar could continue to decline, there's also a myriad of events in the world that could quickly drive buyers to the gold market.

Since 2015, buying gold when it looks its worst and selling it went it's looking ready to explode on the upside has been the optimal approach to the yellow metal. The most direct route for investment in gold is via the bars and coins offered by dealers around the world. The COMEX futures market provides another route for investment and trading positions in the gold market. However, futures are highly volatile and leveraged vehicles that require a separate trading account which limits the addressable market. Futures do an excellent job replicating the price action in the physical gold market because of the delivery mechanism that creates a smooth divergence between the derivatives and gold as contracts expire and markets participants can receive or deliver the gold to satisfy their obligations.

Gold mining stocks tend to outperform the price action in the gold market during rallies and underperform when the price corrects to the downside. Individual gold mining stocks involve additional levels of risk when it comes to each company’s management and their specific mining properties in countries around the world. To mitigate some of those risks, holding a portfolio of diversified mining companies can provide leverage that's available to a broad addressable market as ETF and ETN products trade on the stock market. The VanEck Vectors Gold Miners ETF product (GDX) is a highly liquid instrument with $9.18 billion in net assets and an average of over 39 million shares changing hands each day. GDX holds shares in many of the top gold mining companies in the world. The top holdings currently include:

Source: Yahoo Finance

Gold rallied from $1,161.40 in mid-August 2018 to a high at $1,344 in mid-February, a rise of 15.7%.

Source: Barchart

Around the same time, GDX moved from $17.28 to a high at $23.70 per share or 37.2% as the gold mining ETF provided a leveraged return compared to gold futures on the upside. Since the highs, gold dropped to a low at $1,267.30 or a correction of 5.7% while GDX dropped to a low at $20.14 or 15% as the GDX underperformed gold on the way down.

GDX delivers leveraged returns compared to gold on the upside. When the yellow metal gets close to its next bottom, GDX could enhance your portfolio and is available via a traditional equity account.

The recent price action in gold was disappointing, but there are too many issues to get too bearish, and gold is likely to find another significant bottom sooner, rather than later.

The Hecht Commodity Report is one of the most comprehensive commodities reports available today from the #2 ranked author in both commodities and precious metals. My weekly report covers the market movements of 20 different commodities and provides bullish, bearish and neutral calls; directional trading recommendations, and actionable ideas for traders. I just reworked the report to make it very actionable!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.

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Andy Hecht covers Commodities and Forex as one of the original contributing analysts at FATRADER.com. A former senior trader at one of the world’s leading commodities trading houses, Philipp Brothers (now part of Citigroup), Andy has worked and consulted for banks, hedge funds, and commodities producers and consumers around the world for over 35 years.

In 1792 the U.S. Congress adopted a bimetallic standard (gold and silver) for the new nation's currency - with gold valued at $19.30 per troy ounce