An update on gold (but not frankincense or myrrh)

In Free by Cam Hui

Mid-week market update: There is not much that can be said about the stock market that I have not already said. The small cap seasonal Santa Claus rally that I wrote about appears to be proceeding as expected, though the tape is thin and most professionals have shut down their books for the year.
 

 

Next week is Christmas. It is said that the three kings visited the infant Christ with gifts of gold, frankincense and myrrh. While there is no active and liquid market for the latter two gifts, gold is still traded and an update on the outlook for gold would be timely.

Gold is getting intriguing. Analysis from Nautilus Research indicates that we are entering a period of positive seasonality for gold.
 

 

At the same time, gold stocks are testing a key relative downtrend line. Should it rally further, it would be a signal of possible further future strength.
 

 

Final flush ahead?

However, sentiment models suggest that it may be a little too early to wholeheartedly commit to the long side in this sector. The top panel in the chart below depicts the long-term performance of gold (dark red line) and gold stocks (black, GDX). Both have violated an uptrend line, indicating that they may need time to rest and consolidate before a bull phase can be sustainable. The bottom two panels show that breadth indicators are nearly washout levels, but not just yet.
 

 

The silver/gold ratio measures the performance of high beta precious metal silver to gold. Historically, readings of 0.0125 or less have signaled investor capitulation on gold. Similarly, the % bullish indicator has also been good signals of buyable bottoms when it falls to 15% of less. We are not there yet. In fact, when we zoom into a shorter time frame of the above chart, we can see that the silver/gold ratio rising, which may be an indication that a final sell-off is needed before contrarians can buy at the “panic bottom”.
 

 

Indeed, the latest update of the Commitment of Traders report from Hedgopia confirms that large speculators (read: hedge funds) are selling gold en mass, but readings are not consistent with washout bottoms (annotations are mine).
 

 

Cross-asset market implications

As gold is inversely correlated to the US Dollar, analysis from Hedgopia also indicates a crowded short in the USD, which should provide a bullish underpinning for a Dollar rally.
 

 

This analysis suggests that the USD has room to rally in the short-term. The USD Index is testing a key support level here, if it holds, then watch for to possibly test resistance at the 95 level in the weeks ahead.
 

 

However, USD bulls shouldn’t overstay their long trade. The trend of synchronized global upturn is providing a powerful tailwind for the reflation trade. The copper/gold ratio (red line), which is a global cyclical indicator, is rising, and it is correlated with the stock/bond ratio, which is a risk appetite indicator.
 

 

In conclusion, gold bulls may want to take a partial long position, but don`t go all in just yet. Stay tuned.