Long Term Outlook for Gold Prices Turns Bullish

Long Term Outlook for Gold Prices Turns Bullish

Long Term Outlook for Gold Prices Turns Bullish

For the first time in more than 5 months the gold market has a ‘fundamental’ tail-wind, which is a prerequisite for a substantial rally. We are expecting to see material weakness in the U.S. dollar in September, which should support gold prices through to 2019. 

We see the dollar remaining firm until September, at which point the ECB is expected to announce monetary policy normalization. The dollar could even remain stronger into 2019 if the euro is penalized by uncertainties caused by Italy or Brexit. That being said, in our central scenario we see downward pressure on the dollar by the end of 2018 as other central banks begin to normalize their monetary policy.

Gold Price Outlook – Buy Now

Michael Ballanger – Given the impressive reversal in gold last Monday, which appeared to occur during the Asian and European trading sessions as opposed to the Crimex pit session, it looks like the precious metals are adhering to the well-broadcasted seasonality trade that has been fraught with random, rather than dependable, trading results, especially in the last four years. 2014 and 2016 had poor second-half performances, while 2015 and 2017 were marginally positive. What is reliable is that gold purchases in July have a greater chance for a successful trading outcome than any other month of the year, assuming, of course, that you took profits when gold popped in one of the following five months.

Seasonality
You can see from the chart posted below that in the months that follow July, five out of six have returns that exceed the monthly average, with the standout, September, being followed by corrective behavior in October. It has been postulated that accelerated and highly competitive buying by the Italian jewelry trade and Diwali in India accounts for strong September showings.

seasonal

Oversold Conditions
Conditions in the gold pit are identical to those encountered at major bottoms in the past three years, with RSI (relative strength index), MACD (moving average convergence divergence), and the histograms all in troughs that have led to strong and very tradeable rallies. This is where I take some additional positions on as “trades” and others as “put-aways.” If I can afford a $50,000 bite, $25,000 goes to a trade and $25,000 to put-aways, but the first tranche is designed for a scalp.

concon

Gold Miners (Warning!)
I have been staunch believer in the predictive nature of gold mining stocks since I first began tracking them in 1978. However, the usual Internet blogosphere is once again bountiful with opinionados that think they know more than they actually do. I have used the ratio of gold bullion to gold mining shares in the past and the GTSR (gold-to-silver ratio has usually been strongly reliable in calling the turns, but they are not always reliable as shown by the incredible “fake-out” that nailed us in 2015-2016.

van eck

In late summer 2015, I was buying the JNUG and NUGT calls for February and June expiry all based upon the growing outperformance in November of the miners compared to the metals. However, I stood by horrified in the very early New Year when they started to not just correct, but actually crash. By January 19, 2016, the HUI had broken 100 and the GDX:GOLD ratio was the lowest reading in over twenty-five years.

Gold versus Silver (GTSR)
I am currently short the GTSR, and early last week came very close to lifting the “short gold” leg of that very successful paired trade put on in April at 82.75. I tried to lift it by buying back the GLD shorts, but I was bidding too far under the market ($117.20). The best it could do was $118 on Thursday, only to sag to $117.40 on Monday while I was on the boat in the Massassauga Provincial Park with only intermittent Internet signals. I fear that I may have to simply ride out the paired trade to my 65 target, but that will take a major assault on $21.15 silver and $1,375 gold. If I simply lift the gold short at $1,250 (GLD $118.00), I only need $19.35 silver (SLV $18.10) to accomplish my objective.

silverconcon

The Gold Sector Remains at an Interesting Juncture

Pater Tenebrarum – In an update on gold and gold stocks in mid June, we pointed out that a number of interesting divergences had emerged which traditionally represent a heads-up indicating a trend change is close. We did so after a big down day in the gold price, which actually helped set up the bullish divergence; this may have felt counter-intuitive, but these set-ups always do. Consider now the updated chart below (we have added the HUI-gold ratio in the third panel of the chart, as it provides additional clarity).

Everybody has different reasons for wanting to buy or hold gold – this is actually a fairly good one… :)

Gold, the HUI index and the HUI-gold ratio – it was a “close shave”, but the HUI did not violate its previous low and the divergence with gold was therefore maintained. This is even more obvious  in terms of the HUI-gold ratio, which would have made a higher low even if the index had not.

As the chart illustrates, after our update gold and gold stocks continued to head  down for almost two weeks, but readers watching the sector no doubt noticed that: 1. gold stocks declined only reluctantly and the sector exhibited internal strength (i.e., even on down days, numerous stocks managed to gain ground) and 2. the divergences we discussed remained in place.

Since then, there was a minor bounce in the gold price from a lateral support level created by the December 2017 low, but the relative strength in gold stocks has continued to increase, which is a clear change in character. The HUI-gold ratio even managed a kind of “breakout” by moving above a lateral support-resistance line formed by a previous low and two previous highs (to the extent that one can even speak of “support and resistance” with respect to ratio charts, which is debatable).

Note that the HUI-gold ratio was in a fairly strong downtrend for more than six months before bottoming – very quietly – in mid March. Obviously, not every upturn in the ratio will lead to a significant trend change. The ratio often expands in the short term in the course of gold price rallies such as in the rather disappointing seasonal rally that began in mid-December. In that case it was actually the weakness of the expansion in the ratio that proved to be a heads-up.

The recent case is different, as the ratio has begun to strengthen noticeably in a time of weakness in gold and silver prices. Having said that, the HUI index itself is now facing overhead resistance both from previous price highs and in the form of its still declining 200-day moving average.

While prices have moved above the 50-day and 20-day ma, the latter has not even crossed back above the former yet, and both have only just begun to flatten out. If one squints a bit, one can see minor divergences between the index level and the RSI and MACD oscillators. All in all, the recent advance still looks a bit dubious from a technical perspective.

It would therefore not be a big surprise if the recent rally were to stall out near current levels and was followed by another consolidation phase before a breakout attempt. A successful breakout above lateral resistance and the 200-day ma is ultimately required to confirm the positive message from the divergences at the recent lows.

Per experience, the more forceful such a confirmation is, the more reliable it will be – this refers specifically to the moment of confirmation, regardless of its precise timing. Considering the lengthy bottoming period from mid-2015 to early 2016 (and other historical examples) one has to be mentally prepared for the possibility that it could take a few more weeks or even a few more months before a new medium term uptrend emerges, but it could just as well happen right away.

For long-term oriented investors this should be irrelevant (unless one has the patience of a Zen master, one should not be dabbling in this sector anyway), but short term traders have to be vigilant, as a potentially worthwhile opportunity continues to be in its formative stages.

HUI daily, with moving averages and near term lateral resistance penciled in. Mildly positive divergences with oscillators are in evidence, but major resistance still has to be overcome. Note: when it finally happens, it will happen fast. At that point it is usually best to abandon any remaining reservations.

A Positioning Extreme

Apart from the improving HUI-gold ratio, there is another signal that indicates that traders should be on alert. Since 2007 the CFTC is publishing disaggregated commitments of traders data in addition to its legacy CoT reports. We are keeping an eye on the “managed money” category in this report, which primarily consists of speculative trend followers (mainly CTAs and hedge funds).

This group has held a net short position in COMEX gold futures on just three occasions in the entire history of the report. Two of those were recorded in 2015 – one in the middle of the year and one right at the December low, after which a scorching rally ensued (in about 6 months gold rallied by around $330 from its low, the XAU gained 200% and the HUI 180%).

Due to last week’s holiday the most recent update is already a bit dated (June 26), but it was just the third time the “managed money” group went net short in the aggregate – if only by a handful of contracts (on the chart below the net position is stated as “0”, but in fact it was net short by 24 contracts). After the report was published gold continued to decline at first. It seems likely that the net position of this group of traders subsequently went a bit further into net short territory.

The “managed money” category in COMEX gold futures. Top panel: net position (black line) vs. the gold price; bottom panel: net position (black line) as well as gross short and gross long position (red and green areas). The red lines in the top panel illustrate that another significant divergence has emerged, in this case between net speculative positioning and price.

We want to stress here that we are definitely not arguing that it is always positive when speculators go net short in this market. Very long-term data clearly suggest otherwise – i.e., context is important. In this case, context is provided by the recent improvement in the gold sector’s relative strength against the metals and a likewise fairly recent minor shift in macroeconomic fundamentals, which look now slightly more favorable for gold than previously.

As the chart illustrates, the net speculative position is also increasingly diverging from prices this year, after having tracked them fairly closely from Q3 2015 until Q4 2017. Clearly this market is now potentially quite susceptible to a change in perceptions.

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