What is next for both the stock market and gold? Is now the time to buy gold for protection against a stock market crash?
Let us evaluate the structure of both these markets and discuss protection strategies.
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Silver has enjoyed a modest recovery over the past six weeks, rising from a low of $14.00 in September to $14.70 as this article is being written. What is in store for this dual precious and industrial metal as 2018 closes out? Is there more upside to come or will the downward trend of lower prices from last summer re-exert itself?
Over the next several weeks, we see higher prices in store for silver. However, once this rally concludes, another down-leg should begin for gold’s cousin. Investors should monitor these trends closely as they develop and be prepared for a better buying opportunity early next year.
Let us turn to the visible data.
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There is a fallacy now spreading throughout the precious metals world, and gold investors who believe it to be true will be making a costly mistake when attempting to navigate the volatility in this market over the next several years.
What is the fallacy we are referring to?
Gold’s Commitment of Traders (COT) Report, and the claim of the bullish setup that is being purported on account of the net long position by commercial traders and net short position by large speculators.
Indeed, not a week goes by that we do not see articles published claiming that this myth is in fact true. We will not name any names here in this article, because the fallacy is nearly universally believed, and a quick Google search for “Gold COT report” will reveal dozens of such misleading articles. The time has come to set the record straight.
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Gold has had a rough several months. The precious metal is down some $170 from its peak in April near $1,370, closing today just below $1,200 on the New York COMEX futures market. As we indicated in our last article, gold has failed to maintain the structure that would be indicative of a bull market in progress. That said, no market moves in a straight line, and a reversal will be in store at some point. What are some price projections as gold heads lower over the coming months where we may look to see support emerge?
There are a number of ways to estimate price targets for gold. Established support and resistance zones, Fibonacci retracements, and trend channels are just a few. However, for this article let us focus on a powerful way to gauge the potential for future gold prices – and that is: what the mining complex is expecting.
Gold mining profits are leveraged to the underlying metal price. When the price of gold rises by 1%, gold miner profits typically rise by 2% – 3%, as the underlying costs to mine the metal remain relatively fixed. The same leverage works to the downside of course. The bottom line is that investors in the gold mining sector should have a solid idea of what the price of gold itself is going to do, as the price is a critical determinant of operational success.
That said, let us examine the figures that the gold miners are now pricing in for their own product. This can be a valuable form of analysis to use any time one is preparing to make a sizeable gold purchase.
Below we show the GDX large-cap gold miners fund on top, with the price of gold immediately below it. The GDX contains an average of approximately 50 different mining operations. Let us examine the relative valuations of the two since late-2015:
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Gold’s bottoming attempt following the 2015 low of $1,045 per ounce has failed to maintain a price structure indicative of a rising trend. Consequently, the odds have now shifted significantly that precious metals will not be in a bull market for the foreseeable future. This does not mean that the price of gold is going to crash, nor that an investment in the precious metals sector may not be wise given one’s unique situation. However, with the recent trend failure the highest-probability is that the 2016 peak of $1,378 per ounce will not be overcome for gold for at least the next several years.
Let us examine the current price trajectory and some ramifications.
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The short-term forecast for gold is clear: the metal is set to move higher. Gold has just put in an intermediate low at $1,238 per ounce as of July 3, 2018. Several leading indicators point to an imminent recovery in prices over the next 1-3 months.
However, the longer-term picture for the precious metal is mixed: gold must overcome its 2016 high at $1,378 within the next six months to avoid a significantly bearish outcome that could result in a multi-year decline following such a failure.
The time to closely monitor gold’s price action for one of these scenarios is now.
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Gold is in a primary recovery pattern as it attempts to break above its 2016 peak of $1,378 per ounce. This recovery pattern appears over and over again throughout history – the success or failure of gold to maintain the structure of this pattern will pave the way for either a massive multi-year advance higher in the sector, or a grinding decline to last for the majority of the next decade.
We will have the answer to the question of which outcome to expect within the next 12-18 months.
It will behoove precious metals investors to pay close attention to the technical action and to tune out misleading rhetoric coming from both perma-bulls and perma-bears of gold and the precious metals sector.
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Gold miners, the companies which extract the element from the Earth which has served as the backbone of the global economic system since the dawn of civilization, remain historically undervalued across two key metrics that are used to value the sector. Opportunity for profit exists for those with patience for the sector to revert to the mean.
First, gold companies are undervalued versus the broader US economy: a ratio of gold mining versus the S&P500 index is at its lowest valuation of all time. Secondly and perhaps more interestingly, gold miners remain undervalued relative to the price of the actual metal they produce: gold itself.
As contrarians, these are statistics we should pay attention to. Let us examine the charts.
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Silver is acting weaker than it should be this juncture, just over two years after an important bottom in the precious metals complex formed in late 2015.
From the December 2015 lows in both precious metals at $13.65 per ounce for silver and $1,045 for gold, while both have risen, silver prices have underperformed gold. Since the bottom, silver is up 19.8% to close at $16.36 this week, while gold is up 27.8% to close at $1,336 over the same timeframe. Silver is clearly the laggard of the historic monetary metals amidst the present cycle.
What are we to make of this underperformance in silver? Is there still a possibility for silver to match gold’s performance? Or is this a warning sign that the advances in the precious metals since 2015 are suspect?
The best way to view the relationship between the two metals is through the gold to silver ratio. The ratio tells us how many ounces of silver are needed to purchase one ounce of gold. As of the end of the week, the ratio stood at 81.6.
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Gold has been a part of the human story since the dawn of civilization. One part store of wealth, one part ornament, and one part modern technology, gold stands at the crossroads of multiple financial, religious, and industrial trends.
What actually drives gold prices? Is it fear of currency devaluation or stock market crashes? Is it war? Or is it jewelry and electronics fabrication?
The answer is many-fold. In this article, we will highlight the complex and inter-related drivers for gold prices worldwide so that investors may have a fuller understanding of the totality of the precious metals market.
Gold Supply and Demand
Fundamentally, the answer to what affects the price of gold is the same as for every other market: supply and demand.
Yet the supply and demand balance for gold, a market which dates back to the dawn of record-keeping itself, is itself largely driven by factors which are deeply ingrained in the human psyche.
Two extreme emotions – greed and fear – comprise the spectrum through which the majority of participants in the gold market make their buy and sell decisions.
In this article we will examine the many ways in which greed and fear play out, over and over again, in the most ancient of financial markets which is yet seeing new life today.
Gold Supply
Before we examine the actual numbers, let us consider one important preliminary supply factor for gold: this is the only element in which all of the supply ever mined in the history of the world still exists above ground. Gold never rusts, tarnishes, corrodes, or burns. Except for small amounts which may have been lost in shipwrecks at the bottom of the ocean or disposed of in landfills, all of the gold that has ever been brought to surface of the planet still exists in one form or another (and arguably, those two sub-components are retrievable as well).
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We are now preparing for what should be the final retracement in the gold price before 2016 highs are exceeded for good. The degree to which this retracement gives back recent gains is open to some variability, but the highest probability assessment is that gold will find support over the next 1-3 months within the $1,295 – $1,305 range. The subsequent advance should take prices above the 2016 peak at $1,378 en route to $1,400+ later this year and $1,500 by early 2019.
We expect a correction in gold will now unfold due to the important support zone that is being tested for the US dollar, which should lead to a multi-month rally for the US currency. As a backdrop, investors should recall that typically (but not always) the gold price and the US dollar move in opposite directions. We can observe this inverse relationship with an examination of the two asset classes over recent months:
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Having observed the strength of gold’s surge following the successful retest of its long-term 2011 – 2017 downtrend three weeks ago, the theme for gold now becomes one of working to overcome 2016 highs over the intermediate term. Our focus must therefore change from one of concern that the retest might fail, which implies a more conservative posture, to the health of the long-term basing pattern that is now rounding upward in terminal fashion. We believe new highs for the move that began in 2015 are in store for this year. Retracements will still occur and they will be scary at times, but in the establishment of a new rising trend we should look to be aggressive amidst dips and not fearful on corrections.
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Gold is now completing a pattern which repeats over and over again throughout history. The pattern suggests that a critical low is forming, and that the price of gold is set to begin a new primary advancing trend in 2018.
Note that we are not anticipating skyrocketing prices – such is the realm of headline hyperbole. Further, at this firm we have not been bullish on precious metals from 2011 through 2015. Regular readers will know that no bullish articles were published by this firm during that period: we were waiting for the proper technical signals to align which showed that the declines after 2011 had concluded.
Those signals are now visible. A new advancing trend in gold will set the stage for a markedly different backdrop which will impact short-term traders, investors, and mining companies alike. We must pay attention to these signals as they emerge now and before they are widely-known to avoid chasing markets higher – a strategy which usually results in severe losses.
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The US dollar is on the edge of a decline that may take many by surprise throughout 2018 and 2019. Conversely, gold, the euro and many non-dollar assets stand to benefit. Certain segments of the US stock market may hold up in a falling dollar environment, especially those which can raise prices to compensate. Yet to use the skydiving analogy: the time to buy a parachute for protection is before the falling begins. As usual, we will focus here primarily on technical analysis, and endeavor to avoid the fundamental-only rhetoric that is so often misleading at exactly the most crucial turning points.
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There is a sentiment indicator that exists in the precious metals world that can help us to find high-probability setups for major lows in the gold price – and it comes from the least likely of places: the junior silver mining sector.
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As President Trump prepares to nominate a new chair for the Federal Reserve this week, gold prices remain in a range bound consolidation. Not only has this grinding pattern been ongoing for the last several weeks, but when we examine the price chart for the last five years, we see that gold has essentially been flat as a net sum dating back to mid-2013. And indeed, to the mainstream investor who is primarily involved in a stock market now at all-time highs, gold appears of little interest at the present moment:
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Both gold and Japanese yen have acted as the same asset class for practical purposes since 2011. However, early signals show gold beginning to outpace yen. Investors should not underestimate the impact that a more significant breakdown in this ratio will have on gold prices. We expect a major gold advance to coincide with a break of the lower boundary of the correlation.
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It is often said that in market analysis: “volume precedes price movement.”
Gold has just posted its highest quarterly volume of all-time for futures trading history, for the quarter ended September 30. The closing data shows that for the period, over 17.5 million contracts traded hands. This eclipsed the previous record volume by a whopping 3.5 million contracts. What’s more, the new record surpasses the number of contracts that were traded during the quarter in which gold made its all-time price high of $1,923 per ounce, which came in Q3 of 2011.
Something is happening here in the gold market, for those who would pay attention to the hints now presenting themselves.
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Gold is retesting its 2016 – 2017 consolidation breakout, and the decline seen over the previous two weeks provides an ideal opportunity for precious metals investors to make final purchases before the technical model suggests that 2016 highs will be exceeded for good.
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While ownership of physical gold should be the cornerstone of a precious metals portfolio, we are overweight the miners at this juncture. Despite gains of 100% – 500% in 2016, the gold mining sector is still historically undervalued relative to gold.
Throughout history, ratios between real asset classes revert to the mean when they become radically undervalued, and this time will prove no different. For those contrarian-minded investors who have a higher tolerance for reward and risk than the above targets for gold bullion alone would provide, the opportunities in the gold producing equities are quite significant.
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Gold has finally broken out of a simple yet powerful technical boundary – the declining linear trendline which defined the 2011 – 2017 period in precious metals prices. The ramifications for this breakout are significant and we expect higher gold prices are in store for the next year at minimum.
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Since gold’s all-time high of $1,923 per ounce in September 2011, the nearly 6-year decline that this week has brought prices back to $1,270 has been broadly defined by a falling linear trend of selling pressure. This declining trend is being tested immediately, and a breakout higher would be a major signal that gold’s period of falling prices has come to an end. However, caution is warranted as leading indicators are still flashing warning signals for precious metals prices.
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Unfortunately for gold, we are living through one of those anomalous time periods in which the US dollar and precious metals are positively correlated – but to the downside.
Throughout history, gold tends to have its strongest moves when the US dollar is losing value, as gold receives bids from those looking to protect their savings against a decline in the world’s reserve currency.
However, as we can see at right, especially since the Federal Reserve meeting in mid-June, both the US dollar and gold have moved in the same direction: lower.
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On the heels of the Federal Reserve’s most recent ¼ point interest rate hike on Wednesday, gold and the precious metals complex have seen a negative bearish reversal that deserves caution over the short and intermediate term.
Fundamentally, the interest rate hike and accompanying policy statement, which indicated that the Fed would begin to taper down its balance sheet over the coming year, was interpreted by the market as supportive for the US dollar and negative for gold. As precious metals investors, we know that the Fed has already printed nearly $4 trillion dollar of fresh liquidity in support of the financial system over the past decade, and that the feasibility of the central bank reducing this liquidity by any significant amount is doubtful. Yet what is important over the short run is not so much our fundamental beliefs – but rather how the market itself is reacting.
For example, those who ignored the actual response of the gold market in 2011 suffered severe losses as the precious metals declined through late 2015. All the while, the Fed continued to print money. The market can move contrary to perceived fundamentals for many years. Caution is again advised at this juncture.
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US stocks are overvalued by several major valuation models, but is a top near?
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