David says a stock market rally at the same time Gold is overbought and hitting resistance could trigger a sizeable pullback. Here’s more…
Last week, I discussed the Bull and Bear cases for Gold. The stock market sell-off that began on October 3, the associated fall in bond yields, increasing expectations that the Fed would be forced to reverse policy, recent weakness in the dollar, and Gold rising in yuan terms have all contributed to Gold’s rally since September 28 th.
The rise in XAU/CNY, in particular, has finally cast some doubt on the “yuan as good as Gold” argument, as the yuan has weakened ~9% against Gold since August 16 th. For those who still question the China connection to Gold, this was also the same day that Gold bottomed at $1167. USD/CNY has been relatively stable since then, so all of the move in XAU/CNY factored into Gold’s rise in dollar terms. Why would China devalue the yuan in Gold terms? Perhaps because the previous midpoint for Gold at ~8200, yuan was deflationary for China at a time when it is dealing with slowing domestic growth and a trade war with U.S. This could continue to support a Gold rally in dollar terms, but the risk remains of a sharp move higher in USD/CNY if the U.S.-China trade dispute escalates.
Since July, my base case for a sustainable bottom in Gold and a massive rally to follow has been a Fed reversal in policy that would mean the peak and fall in the dollar and USD/CNY. Given the ~25% drop in the S&P since its all-time-high at 2941 on October 3, expectations for a Fed policy 180 to rate cuts and QE have risen dramatically. This is most evident in market forecasts for interest rate hikes in 2019 being erased almost overnight and the drop in the 2-year treasury yield from 2.98% to 2.54% today. The risk to this scenario is that stocks rally significantly without a Fed reversal in policy, increasing expectations for rate hikes in 2019 once again and weighing on Gold prices. However, as I shared in my previous article, I do not believe we can have a sustainable bottom in stocks without a Fed reversal in policy, so any rally ahead of that is doomed to fail, in my opinion. The key question is how low we go in Gold terms if and when such a stock market rally occurs. In the short-term, it looks like we are due a pullback in Gold soon.
Stocks remain near their lows and could go down to lower lows yet, but the odds of a significant rally are increasing. Gold has risen $114 from its low of $1167 and is now extreme overbought short-term per its RSI. Gold is also setting negatively divergent higher highs per its DSI (Daily Sentiment Index) and MACD Histogram. Its MACD Line is now higher than its April peak at $1369 and approaching February peak levels.1293 is the 61.8% fibonacci retracement of the entire decline from 1360 to 1184 on a closing basis.Gold’s rally is also parabolic in nature, and those are the most fragile to breakdown.
Lastly, Gold is also running up against its weekly and monthly trendline since the bottom in December 2015, former support now resistance. And the month of December is almost done.
At the end of the day, we have not seen the inevitable Fed reversal in policy “yet”, and the risk of escalation in the U.S-China trade dispute remains a risk. A stock market rally at the same time Gold is overbought and hitting resistance could trigger a sizeable pullback. The key question is: how low do we go? That said, the Fed will be forced to reverse policy or risk total collapse of the stock market and monetary system, and Gold will soar once that reversal occurs. Its recent rally confirms this. So use the coming decline to average in on the long side, in my opinion. Gold is only going higher long-term.