Can One Trust Gold Price’s Friday Rally? Here’s the Context.
Last week, gold price moved sharply lower but rallied back up on Friday. Which direction is the real one?
While possible, it’s quite often not the most efficient way to proceed, and sometimes one can waste a lot of energy on sub-optimal solutions. Or one can miss a great deal of benefits that would be available if one approached this situation from a different angle.
Take dieting, for example. Some people (most?) would like to get rid of some extra pounds (or kilograms). Some have quite many of those “extras”. And what do they usually focus on? On eating less or eating better quality foods. And it works.
However, in many cases, it works for just a while, it takes a lot of willpower and is inconvenient in all sorts of ways. There are ways to minimize the inconvenience and maximize efficiency (I used and think very highly of Tim Ferriss’ slow carb diet, by the way. You can read about it in this book “4 Hour Body”), but again, there’s the issue of getting stable and not just initial successes.
In this case, achieving success is possible, but it’s difficult, and the stability of that success is a different matter.
In this case, looking at the challenge at hand from a different point of view, could be examining why does one tend to overeat in the first place. Stress eating? Not enough enjoyment of life in other areas?
There could be quite many reasons, but the point is that addressing whatever the real reason is, can make the changes in one’s body composition stable. Why? Because without the real reason, everything that one “fighting” like the urge to eat more or sweeter foods will simply no longer be there. And it would happen easily and lightly.
Of course, there’s much more to the above, but I won’t go into details here, as that’s not the point of this analysis.
Why did I mention the above at all? To show you how looking at something from just the basic level can be a sub-optimal way of doing things.
In our case, the gold price rallied on Friday – that’s a fact. But what is the context? What happened in other markets? What is the overall market tendency right now? Knowing the above, can change the rally from “perplexing” to “obvious”.
As far as the overall tendency is concerned, I already covered it in Friday’s huge Gold Trading Alert, but to make a long story short, the odds are that we’re now in the “return to normalcy” stage of the bear market, which is particularly tricky, as that’s when investors still think that it’s a bull market’s return.
I’m applying this to the stock market, but it has consequences for other markets as well. In particular, this makes investors particularly vulnerable to emotional price swings to the upside that have little fundamental merit.
Looking at gold price only, we see the following:
Gold declined by almost $40 last week, and it was the lowest weekly closing price since mid-March. Both are bearish indications, especially the latter as it implies that last week’s move was indeed important.
What about Friday’s comeback?
Markets are emotional in the very near term, and they easily focus on what was the most recent news out there. If it sounds scary, people can flock to gold, even if it’s pointless.
On Friday, Powell spoke about interest rates, and he said pretty much nothing new. They will assess the risks on a meeting-by-meeting basis – nothing new.
What caught public’s attention was the pause in the negotiations about the debt ceiling.
“Oh no, the U.S. can default on its debt obligations!” – that pesky thought entered anxious investors’ minds once again.
Pointlessly so because it’s practically impossible for anyone to willingly take blame for nation’s default. Especially when the U.S. needs to be fully credible. I’m not talking jut about the war in Europe, but also about tensions regarding China.
That’s why I wrote the following in Friday’s intraday Gold Trading Alert:
Powell just spoke about rates, and he said very little new. They (the Fed) will make the interest rate decisions on a meeting-by-meeting basis depending on the data. That’s what they already said before, so it changes nothing – also with regard to the fact that the markets are most likely overestimating the odds for the rate decreases in the coming months. But I already wrote a lot about it this week, so I don’t want to go into details once again.
What I would like to comment on is the debt-ceiling debate. The debt limit talks came to an abrupt standstill. The Republican House Speaker said it's time to “pause” negotiations.
What does it change?
They will practically certainly (I’d give it 100% chance, but since there are no certainties on any market, I’m not saying that it’s certain) increase the debt limit, because nobody will want to be the person responsible for the U.S. default. Especially given the war in Europe, and tensions regarding China. Can the U.S. afford to be viewed as weak now? Come on…
Then again, they can’t just state the obvious and say, “you know, we really have no way out of this debt spiral and when we do try to implement something, it will already be after you have already suffered losses from your stock investments that will be so huge, that you’ll accept just about any solution”. That would be a form of weakness, too, right?
So, no. I can’t happen like that.
Consequently, instead, we have smoke and mirrors. A dance. A fake argument. Nothing more. And nothing that impacts our positions as whatever the market does based on the fake disagreements, will be undone once it’s clear that the debt ceiling will indeed be raised.
Zooming in, allows one to see that the move higher was nothing to write home about compared to the size of the preceding decline.
I provided the fundamental context, so we looked at the situation from a “higher level” than by focusing on the price moves alone. Now, let’s do the same from the technical point of view.
This time, the critical context is provided by the mining stocks. And more precisely, by the fact that miners were weak relative to gold.
While the GLD ETF (proxy for gold, which I’m using to have an apples-to-apples comparison with GDX and GDXJ) moved above its early-May lows, that didn’t happen in case of GDX or GDXJ – proxies for senior and junior mining stocks, respectively.
Miners tend to be weaker than gold during declines, and they tend to be stronger than gold during upswings, especially in upswings’ early parts.
This is the extra angle that one wouldn’t get while looking at gold price alone. Thanks to knowing how miners performed relative to gold (poorly), one can estimate, what’s the most likely outcome with greater accuracy than without this information.
Given what miners just did, the odds are that Friday’s upswing was just a correction and not the beginning of another bigger rally.
Moreover, please note that GLD, GDX, and GDXJ tend to either “close the gaps” or correct in the “gap’s territory”. And that’s what we saw once again on Friday.
A price gap is created, when a given market opens well below or above the closing price from the previous session. The space between the previous days’ close and the new open is a “gap”. It’s essentially a group of price levels at which there was no trading as the markets were closed.
Gold and gold miners tend to then – after such a price gap is formed – to move back to the previous closing price and then continue the trend.
We saw something like that earlier this month, and we saw it on Friday.
What does it mean? It means that since the gap was closed / almost closed, the precious metals sector can now decline once again – quite possibly in a profound manner.
Also, here’s more “extra context”.
In Friday’s flagship Gold Trading Alert (if you just joined and haven’t had the chance to read it, I encourage you to do so), I wrote that I don’t really trust S&P 500’s breakout above its previous May highs.
Indeed, that move was quickly invalidated in intraday terms. During the overnight trading S&P 500 moved back to the previous high once again but failed to rally above it. This could be the end of the rally in stocks and the beginning of another huge move lower. The world stocks provide most context for this, but I just wrote about it on Friday.
This is important, because in the preceding months, stocks rallied together with the precious metals sector, and the link between stocks and junior miners is particularly strong.
Recently, it seems like the precious metals sector (in particular junior miners) really wanted to move lower and they declined even without stock market’s help, but when they finally do get this bearish help, junior mining stock prices are likely to truly slide.
The same goes for the FCX, in which we continue to hold profitable short positions (entered in early April) – those profits are likely to increase substantially soon. And profits from a short position in the GDXJ is likely to join in as well.
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Przemyslaw K. Radomski, CFA