Are We Done Yet?

From the November 18, 2014 HRA Journal: Issue 223

Was that it?   It’s too early to say but the move off the $1130 is the largest up leg in over a year if it holds.  That alone forces us to seriously consider that we may have just seen “the” bottom even if technical traders don’t believe it.  

The bears are not out of ammunition yet however.  The Indian government is not happy about the level of gold imports and there is no way to tell how large the bullish bets on the November 39th gold referendum in Switzerland are.  Bad news on either front could give chart traders the bottom they are wishing for.  I’m timing the next Journal issue for the date of the referendum because it could have a very big impact.

There has been some, but only some, let up in the pain where the Venture index and GLX and GDXJ are concerned.  There is no evidence we will see any sort of washout volume on the Venture at least.  It seems traders all expect a bad moth and bids have been pulled.  In many cases this led to no volume rather than sellers hitting the lower bids.   That might change as we near the end of tax loss season but it seems sellers are not willing to go lower in most cases.  That may have put a bottom on the index as long as gold holds up and oil doesn’t see yet another $10 drop. 


Things have certainly been interesting lately. After the vicious selloff that followed last month’s Fed meeting gold remained under pressure, reaching a low of $1130 a few sessions ago.   There are many chart analysts that view $1100 or less as the “logical” level for gold to bottom out, though an over shoot to the downside, perhaps a large one, is always possible.

Is $1130 close enough?   It certainly is for me.  I’ve always found the extreme precision of TA targets to be a bit facile. Maybe I think life is too complicated but in my experience markets are fluid ever changing landscapes.  The goalposts move constantly. Three percent is a pretty small error range against that backdrop.

I hope it’s close enough for everyone else but market watchers are still 100% bearish. 100% bearishness is a bullish indicator but leaves open the possibility of self-fulfillment.  If all those bears have a few more trades in them they can still push the price lower again. Most still expect at least one more leg down in prices in order to fulfill their definition of a “washout low” sometime in the next few months.

I reproduced one month charts for both gold and silver on the following page.  I don’t usually spend a lot of time looking at short term charts but these help display the wild swings in both markets in the past month.  It’s easier to see the impact of two “freaky Fridays” in a row in terms of the size of the daily swings and the volumes.

Gold looked done for just over a week ago, with the Japanese QE program, a Fed statement that looked hawkish, a good payroll report and Q3 GDP number for the US.  The $US was soaring and gold and commodities were getting pummeled.  Things changed suddenly though, thanks to news out of Germany and the US.

The US centric financial press “blamed” it all on the October payroll number.  It was a bit lighter than consensus but only a bit.   The real turn actually came overnight when Germany released trade and current account numbers that were a solid beat of expectations.  Gold was trading at $1130 when those came out but turned immediately and was in the $1145-50 range when the October payroll report was released.

What was really different about the last two Fridays was the strength shown by the buy side and the overall trading volume.

The first reversal (November 7th) was short lived which perfectly fits the bearish narrative.   Bear market rallies can be sudden and large but they tend to break down almost immediately.  That is exactly what happened though the gold price did hold well above its low prior to the November 7th move.

One week later gold staged another reversal and, again, it seemed to go against generally good US numbers.   Again, it seemed to be Germany that started the turn.  Gold had fallen back to the $1145 level before the US released good retail sales and consumer confidence numbers.  That was shortly followed by Q3 GDP numbers for Germany, France and the EU as a whole that were all better than consensus.  On top of that were reports from NATO of Russian convoys delivering supplies and perhaps troops to the eastern Ukraine.

The real knockout punch was Germany tabling its government budget in advance of the G20 meeting in Australia. I don’t know how to say “giving them the finger” in German but the budget clearly involved some digital symbolism on the part of Chancellor Merkel.

Merkel is promising a balanced budget next year.  That’s a good thing but it also means there will be no fiscal stimulus coming from the one country in the EU that can really afford it.  Traders viewed the budget as evidence Germany is likely to fight against a European QE program.  I’ve thought that all along.

Traders who feel fresh monetary easing isn’t coming now started closing short Euro positions as did traders who expected weaker economic readings.  That added a cent and a half to the Euro’s value and added steam to the gold rally.

All of these items together preceded another reversal.  Gold moved up $48 and closed near its high at $1188.  The volume was again very strong.  On both the reversal days there was almost constant buying that triggered buy stops over and over through the day.

Both days have been described as “short covering” which is financial journalist lingo for “we don’t know what the hell just happened”.  There was short covering, obviously, but it was being triggered by buying volume.

Traders in the commodity pits remarked there was heavy physical demand coming in though they didn’t seem to know who the buyers were.  Futures market data is more out of date (the COT report cutoff is three days before the last reversal) and that certainly doesn’t indicate who the buyers are.

Traders and hedge funds have cut their bullish bets dramatically through the past three weeks. Retail owners of GLD and other gold ETFs have done the same.   That too is ultimately a bullish sign overall since hedge funds and retail both tend to be late and wrong.

The second freaky Friday was preceded by a period of diving gold forward (GOFO) rates.  The gold forward rate is the interest rate charged to swap gold for cash for a specified period, usually one, three or six months.

The party lending the cash is being compensated for the risk free return they could earn holding the cash in short term notes. For that reason it tends to parallel the short term LIBOR rate under normal conditions.

Recently, the GOFO rate went strongly negative. That means traders are paying to swap cash for gold rather than getting paid for it.  That is a sign that the physical market is very tight and traders are having trouble sourcing bullion.  Almost every period of negative GOFO rates in the recent past was followed by a rally in gold prices.  So far it looks like things will be no different this time.

Interestingly, in the midst of all this market mayhem I have seen no change in posture among the analyst community or among the wide variety of traders and insiders that I talk to in the resource sector.  Overall sentiment seems more bearish than it did a few weeks ago, though that hardly seems possible.

Several high profile gold bulls have recently thrown in the towel.   Most of the technical analysts have not changed their calls for a bottom at $1100 or less.  Most, in fact, have completely ignored the events of the past week or so.   Does that mean we should too?

The biggest risk to the gold price is the US Dollar.  Gold can and should be viewed as a currency in its own right and just about everyone who trades it quotes and thinks of the gold price as “gold in US Dollars”.

It’s not a meaningless distinction.  The gold price has had almost perfect negative correlation to the Dollar lately, but only to the dollar.   In terms of almost all other currencies the gold price did not see the breakdown that we witnessed in the dollar price in the past few weeks.

In order for gold to resume its bull market one of two things needs to happen; either the US Dollar tops or the negative correlation with gold weakens.   Both happening at once would be even better.

Because analysts almost universally think in terms of “gold in US Dollars” skepticism abounds when it comes to high gold prices.   I am sympathetic to that view.  The Dollar is the world’s strongest currency right now and there are few if any reasons why that should change. US economic readings continue to outperform other areas and the odds of the US moving to a higher growth track are better than they are for other economic blocks. That said, the Dollar Index is at a level that has proven tough to get through before.  Though the economy is still lousy in Europe the recent surprises have at least been positive ones which helped the Euro.

Whether that lasts remains to be seen.   The Dollar may weaken of its own accord when traders feel it’s too overbought.  There are plenty of reasons the USD should rise but long dollar is a very, very crowded trade right now.

As this issue was being completed Japan delivered the biggest surprise of all.  Tokyo reported on Q3 GDP and it was a miss of gargantuan proportions.  Q2 was a big negative thanks to a sales tax increase that put off shoppers.  The market expected some bounce back from that, with consensus estimates of 2.2% annualized growth in Q3  Instead, Tokyo reported growth of negative 1.6% annualized, a miss of 3.8%.  Now we know why the BoJ decided a week ago to embark on such a large new QE program.

In a rational world the Yen would have been crushed but markets aren’t that simple.  Traders are betting the next sales tax increase gets shelved and that Prime Minister Abe comes up with more stimulus.  True or not this has traders on the buy side in the Yen/Dollar trade.

This may be a one day wonder but the chaos in the currency markets is supporting gold.  So far it hasn’t dropped back much and is holding above $1180.  If $1180 becomes support again after failing last month we could see more shorts losing their nerve.

The other piece of the puzzle I bring up constantly is physical demand.  According to the World Gold Council Chinese gold demand fell by over 40% in Q3.  As I have already written I don’t trust WGC figures.  Other demand numbers derived directly from Shanghai gold market withdrawals match numbers from the China Gold Council much more closely.  Those are down from last year but not much.

Another market that has come back in a big way is India.  Gold imports to India accelerated rapidly in Q3, exceeding 150 tonnes.  This could be a short term blessing but a medium term curse.  We may see tariffs raised again.  That would be a negative for the market but might just increase smuggling as Indians seem determined to take advantage of low prices.

The other big buyer was Russia.  The Russian central bank has added over 100 tonnes to its holdings this year.  This is very much in line with Putin’s desire to diversify away from the USD.

Given the chilly reception Putin knew he would get at the G20 meeting and stories of troop movements in Ukraine I wouldn't be surprised if Russia is one of the current mystery buyers in the gold market.   Putin is more than happy to indulge in digital symbolism, especially where the US is involved.  The strengthening greenback and collapsing ruble is probably making him crazy.

There is still the supposed “elephant in the room”, namely the Swiss gold referendum that takes place on November 30th.  That could be a game changer.   I will go into that in the next issue which will proceed the referendum.  If gold keeps moving higher you’ll be hearing a lot about it as market watchers try to come up with a reason gold isn’t moving the way everyone said it would.  I’m not convinced (yet) that it’s having a big impact.   At least I hope it isn’t.   I would much prefer a referendum win—if that happens—get priced in after the vote not beforehand.

If gold can move a few dollars higher in coming sessions and defend the $1180 support level we have a tradable rally on our hands and perhaps a real bottom.  Gold’s bounce has had a positive impact on stock prices that were decimated through September and October.   The Venture Index has been basing and getting a little traction.  We still have 4-5 weeks of tax loss season ahead of us.   Bids have been light as traders and brokers expect selling but only some of those bids are getting hit.  This reinforces my thought that this may be a low volume bottom as long as gold doesn’t fall out of bed again.  Barring a big uptick in selling volume the Venture may have finally gone as low as it’s going to. We’re certainly due for better markets.

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