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Rallying Gold, Declining USDX, and the CoT Comments

 -- Published: Wednesday, 7 November 2018 | Print  | Disqus 

The US elections are over and since the markets were not surprised by their outcome, there was no significant reaction. It seems that the markets can now return to their previous trends. ButÖ the USD Index is down significantly today, while gold and silver are rallying. Does it mean that the trend in the precious metals is currently up?


Not necessarily. The US-elections-driven volatility could extend beyond the very initial reaction and itís not surprising to see the move higher in the PMs and miners today and along with a move lower in the USDX. What is interesting, however, is the subtle clue that the relative changes provide.


Gold and silver are practically where they were 24 hours ago, while the USD Index is considerably lower.


USD Index and Its Inverse H&S Pattern


Being about 0.50 lower today (at the moment of writing these words), the USD Index is already visibly below the previous November low. This is a clear sign of weakness of the precious metals sector. The PMs should be rallying, but they are not.


But doesnít this move invalidate the recent inverse head-and-shoulders pattern?


In a way it does, and in a different Ė more important Ė way it doesnít. The line that weíve been featuring on the above chart and the one thatís being broken today (the rising red line) is based on the intraday highs. As you may recall, the closing prices are more important and thus the formations based on the closing prices of the USD Index can be viewed as more important as well. The neckline of the inverse head-and-shoulders pattern thatís based on the closing prices is currently at about 95.25. Todayís pre-market low (so far) is 95.68, so the USD Index didnít invalidate the breakout above the inverse H&S pattern in terms of the closing prices. Consequently, even though we may see some short-term weakness in the USD Index (by the way, we cashed in our profits from USD-long forex positions yesterday, before todayís decline), the main trend remains up for the following weeks and months.


Moreover, please note that the reflective nature of the 2017 decline and 2018 upswing remains in place and back in 2017 the USDX moved a bit below the dashed, red line, relatively close to the dashed blue line. Even if the USD Index declines even to the neckline of the short-term inverse head-and-shoulders pattern (95.25), the above analogy will remain intact, and it will continue to favor higher prices in the following weeks and months. The outlook, therefore, remains bullish for the USDX and bearish for the precious metals market.


Since both: gold and silver are practically where they were when we published yesterdayís Gold Trading Alert, all the points that we made remain up-to-date, especially the one about the possible short-term volatility:


The implication is that this build-up in transactions that were not made but are planned may cause bigger volume today and in the rest of the week along with increased volatility. We saw something similar in late February 2018, when gold declined on very low volume. What followed was a quite sharp upswing that was invalidated before the end of the session. There are also bearish examples. For instance, in early August 2018, low volume readings were followed by a big decline.


There were also cases, when low volume was not followed by anything special, so the quality of the signal is not particularly high, but itís important to keep the above in mind nonetheless. Why? So that any temporary price upswing doesnít come as a surprise. Just like what we saw in February 2018, or like what we saw two years ago after Trumpís victory, the upswing would likely be very temporary. To be clear, even if we see a temporary upswing, we donít expect it to be even close to the size of the upswing that followed Trumpís victory. The latter was a huge surprise to the markets and implications appeared very significant. We are unlikely to get a big surprise this time and the implications will not be as significant the previous ones.


The more important implication of the US elections is that they will be over soon. Sounds trivial, but itís important that the tensions will subside. Itís likely one of the main factors thatís been preventing the precious metals market from declining.


While weíre discussing the situation in the USD Index, we would like to take this opportunity to reply to one of the questions that we recently received.


Inverse H&S in the USD Index - Too Slanted?


The question was if the medium-term inverse head-and-shoulders pattern thatís still being formed is not too slanted to be reliable. In short, itís not even close to being too slanted. Naturally, if one features it on a chart that suppresses the time axis then it will be very slanted, but thatís not the point. In normal scale, the upward slope of the neckline of the pattern is reasonable and doesnít appear to invalidate anything.


There are a multiple definitions of the H&S patterns, but itís hard to find a definition that would penalize the formation for not having shoulder extremes at identical height. Most likely all of them point to any implications of the formation only after itís completed, though.


There is an interesting note on Stockchartsí definition:


Neckline: The neckline forms by connecting low points 1 and 2. Low point 1 marks the end of the left shoulder and the beginning of the head. Low point 2 marks the end of the head and the beginning of the right shoulder. Depending on the relationship between the two low points, the neckline can slope up, slope down or be horizontal. The slope of the neckline will affect the pattern's degree of bearishnessóa downward slope is more bearish than an upward slope. Sometimes more than one low point can be used to form the neckline.


The above is about the regular H&S pattern as the website doesnít have a specific definition for the inverse H&S, but itís safe to assume that in case of the inverse pattern, the fragment that we put in bold would be:


The slope of the neckline will affect the pattern's degree of bullishnessóan upward slope is more bullish than a downward slope.


One might ask if there is a point after which the pattern becomes too slanted, and this might be the case, but it would be at much more extreme examples than the one that we currently see in the USDX.


Interestingly, this doubt becomes ridiculous if it accompanied by oneís conviction of the meaningful nature of the recent inverse H&S in the gold stocks.


The above chart features the HUI Index (proxy for gold stocks thatís particularly useful Ė for instance because itís not being impacted by ETF fees like the GDX ETF is) in the background; itís marked with black candlesticks.


The time scale is identical, so the slant of both inverse H&S patterns is comparable. The neck level of the USDX pattern is marked with rising blacked dashed lines. Weíll use the thin dashed black line as itís based on the intraday prices. The purple declining line the neckline (and its extensions) of the pattern in gold stocks.


At the first sight itís clear that the neckline of the inverse H&S in the gold miners is more slanted than the one in the USD Index, but to be sure, we created the horizontal thick purple line and we put it at the necklinesí intersection. We then marked the distance between it and both lines with identical purple dashed vertical lines. This comparison allows us to see that the slant of the neckline of the inverse H&S pattern in gold stocks is more than twice the slant of the neckline of the inverse H&S pattern in the USD Index.


Consequently, if one wants to say that one of these patterns could be invalid because of its slant, it would be the pattern in mining stocks, not the one in the USD Index.


Speaking of the inverse H&S pattern in the mining stocks Ė did you know that this pattern doesnít even exist anymore in case of half of the sector? The above ďhalfĒ assumes a simplification that there are only gold miners and silver miners. Obviously, there are companies that mine other precious metals, but the most popular PMs are gold and silver, so this assumption is quite close to being correct from traderís point of view.


Silver Miners and the (Lack of) Inverse H&S Pattern


The silver miners declined after the huge-volume-spike signal just like we expected them to, but the key thing that we would like to emphasize is their position relative to the previous inverse head-and-shoulders pattern. It was invalidated in case of both: gold stocks and silver stocks. But, while the HUI Index is once again above the neck level of the pattern, the silver miners are not. This means that even though there are some points of view, in which the formation appears to remain intact (the GDX ETF), it really shouldnít be trusted. There is no formation to speak of in case of silver stocks anymore, and the HUI Index has already invalidated the formation, so even though the price is once again above the neck level, it doesnít make the picture truly bullish even for the short term.


There are three more questions that weíll address in todayís free gold analysis. One of them is about the volume that accompanied the mid-October rally in gold. The question was if the size of the volume confirmed the bullish implications of that session and if we shouldnít view the outlook as bullish because of that.


The Comment-based Analogy and Its Implications for USDX and Gold


Our reply is that, if possible, itís always useful to look at the context of what happened and to take it into account while discussing implications. Itís not always the case that we see what was the likely reason behind a given rally, but it was the case in mid-October. That was right after Trump publicly criticized the Fed for raising interest rates.


On October 15th, we wrote the following:


Besides, if yesterdayís action was indeed caused by Trumpís comments (which may not really represent his true opinion on the matter), we have a guideline from the past on how temporary the effect might be. In January 2018 Treasury Secretary Steven Mnuchin said that the U.S. would welcome a weaker dollar, which was something that anyone in his position should have never said, so that surprised the market. The USD Index declined and gold soared based on these comments. The next day, January 25th, 2018, gold formed its 2018 top in terms of the closing prices. In other words, in terms of the closing prices, higher gold prices were never seen since that time. The volume in gold was huge at that time. In fact, that was the only time from the recent past when goldís volume was comparable to what we saw yesterday.


There are even more similarities. Gold stocks rallied above the previous highs just like they did yesterday. It all looked very bullish at the first sight and it generated a lot of feedback and questions. We received numerous questions recently as well, so the situation is similar also from this point of view.


The emotions were high in late January 2018 and they are high now. But, itís our job to stick to the facts and logic and analyze the emotionality instead of being influenced by it. In the January 25th, 2018 regular Gold & Silver Trading Alert we wrote about 50% of the regular short position in gold, silver, and mining stocks, and in the intraday follow-up we increased this position to 150%. It was indeed an excellent time to enter, not exit a short position. And the same appears to be the case today. Surely, we may have temporarily (in the next several hours or so) higher prices, but the odds are that this is a shorting opportunity in disguise.


The January 2018, comments by Steven Mnuchin were followed by USDXís bottom and the same was the case in October Ė the USD Index started another rally shortly after Trumpís ďcrazy commentsĒ. The history repeated itself as we had indicated, and we saw a confirmation of the analogy between these two cases.


What about the precious metals? Their performance is also quite similar to what happened in January and the following months. The key fact is that the rally was mostly over after the comments-based upswing. To be 100% clear: gold, silver and mining stocks did move above the closing price of the huge-volume session, but this move was not significant (and the same thing happened in January).


What happened next? In the first half of this year, we saw back and forth movement in gold and a more decisive (but nothing epic) decline in silver and mining stocks. What happened recently? Gold just closed more or less where it had closed on October 11th Ė the day of the huge-volume rally. At the same time silver and mining stocks closed visibly below their respective October 11th closing prices. The history is being repeated.


Consequently, huge gold volume (and the huge volume in the GLD ETF) in mid-October is not a bullish factor. Itís a confirmation of the analogy to the late-January 2018 situation where the price moves were triggered by comments from the US officials that shocked the markets.


This analogy has bearish implications for the following weeks. In the short-term, however, it means that the upside is very limited. This analogy doesnít say anything about the starting date of the next big breakdown in gold, but based on other factors Ė for instance based on the situation in the USD Index and on todayís strength of goldís and silverís reaction to the weakness of the former Ė it seems that we will not have to wait much longer.


CoT Report and Its Declining Usefulness


There was also a question about the current position in the CoT report, but we have already discussed the usefulness of the CFTCís CoT numbers. We commented on the CoT usefulness (and limitations) in late July, 2018. As many analysts reported, the numbers were very favorable and they were about to make gold shine again. Instead, gold declined in the following weeks. Of course, silver was supposed to soar to the moon based on its own CoT situation. It was over $15.50 back then. GDX was above $21.50. Higher silver and mining stock prices were not seen since that time. To be precise, there was a small upswing in silver on the day that followed our July 25th, 2018 analysis, but in terms of the closing prices, the July 25th 2018 session was not exceeded.


In short, the gold CoT report was very useful tool about 15 years ago and its usefulness declined since that time. Moreover, itís highly unlikely to indicate a major breakout, major breakdown or provide insights regarding the final bottoming targets and one of the reasons for it is because the commercialsí and non-commercialsí positions donít have one set minimum or maximum at which the price reverses.


Some may say that itís different with gold hedgers positions (in fact, the final question that we received was about these positions). But itís not.


Please take a look at the chart below.


The above chart covers about 2 years. In the upper part of the chart you have the price of gold, and in the lower part you see the gold hedgers position. As you can see tops in the blue line correspond to bottoms in gold. Moreover, the blue line is just after a move to the previous highs and its resistance line (marked with green). Gold is also close to the previous bottoms. So, the bottom is in, right?


Letís zoom out.


The previous chart showed you what appeared likely right before the April 2013 slide. The price of gold plunged, and the hedgers positions simply increased, well above the previous highs and above the green resistance line.


Whatís the current situation? The blue line is just after a move to the previous highs and its resistance line (marked with green). Gold is also close to the previous bottoms. How can the implications be bullish, if the very similar situation from the past preceded the biggest slide of the decade?


Some may say that the position canít increase further and thus gold canít decline further.


But why should this be the case?


The volume level in gold futures (and in other futures contracts in general) increased substantially in the recent years. Consequently, the numbers in the CoT reports can be substantial and their swings can also be bigger than in the previous years. This further validates the point that we made earlier when discussing the declining usefulness of the CoT reports. If you look at the volume levels before 2006, they are quite stable. But, since 2007, their levels increased substantially, and we saw another big increase in 2017.


The change in the data regime is very important and every analyst should make sure that the tools that they are using remain useful in light of the change. The usefulness of the CoT-based gold signals declines and itís very far from being the Holy Grail of signals that itís portrayed to be.




Summing up, the outlook remains strongly bearish for the precious metals sector. Goldís very weak reaction to todayís pre-market decline in the USD suggests that we will likely not have to wait much longer before the decline in the precious metals sector resumes, especially that the US-elections-driven tensions are likely to subside shortly.


To be clear, gold is still likely to rally to $6,000 or so, but not before declining significantly first.


On a side note, before calling us perma-bears, please note that we were bullish (in terms of long-term investments) on precious metals for years Ė until April 2013. Weíre looking for the true bottom in the precious metals sector, not because weíre its or gold investorsí enemy. Conversely, weíre that true friend that tells you if somethingís not right, even if it may be unpleasant to hear.


Thank you.


Przemyslaw Radomski, CFA

Editor-in-chief, Gold & Silver Fund Manager

Sunshine Profits - Effective Investments through Diligence and Care



* * * * *


All essays, research and information found above represent analyses and opinions of Przemyslaw Radomski, CFA and Sunshine Profits' associates only. As such, it may prove wrong and be a subject to change without notice. Opinions and analyses were based on data available to authors of respective essays at the time of writing. Although the information provided above is based on careful research and sources that are believed to be accurate, Przemyslaw Radomski, CFA and his associates do not guarantee the accuracy or thoroughness of the data or information reported. The opinions published above are neither an offer nor a recommendation to purchase or sell any securities. Mr. Radomski is not a Registered Securities Advisor. By reading Przemyslaw Radomski's, CFA reports you fully agree that he will not be held responsible or liable for any decisions you make regarding any information provided in these reports. Investing, trading and speculation in any financial markets may involve high risk of loss. Przemyslaw Radomski, CFA, Sunshine Profits' employees and affiliates as well as members of their families may have a short or long position in any securities, including those mentioned in any of the reports or essays, and may make additional purchases and/or sales of those securities without notice.


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