2. Peak Dollar
The Fed was dovish on Wednesday—just not dovish enough for the stock market. Even though the Fed raised rates and plans to continue to do so and reduce its balance sheet further, the dollar has been falling since anyway.
On December 14th, when the DXY was once again testing its prior high at 97.50, I shared the following on my site, globalprotraders.com:
“Momentum is clearly deteriorating, as you can see from the inverted parabola in orange on the daily chart… Dollar long positioning by Large Speculators (the dumb money) is at its highest in 3 years… Sentiment is also negatively divergent on the spot DSI (peak 95, yesterday 73) but more importantly, per the 21-day moving average, which has already peaked at a negatively divergent high and is now falling.”
Put simply: the dollar was ready to fall, and fall it did. But what if it is falling because it, too, is anticipating the inevitable reversal in Fed monetary policy?
Gold’s inverse correlation to the DXY broke down recently in favor of USD/CNY, but now it seems to be returning. Should the dollar continue to fall, this would be extremely bullish for Gold.
3. Gold in Yuan terms, or XAU/CNY
With USD/CNY relatively fixed in a range between 6.80-6.97 since August, it is XAU/CNY that is driving Gold in dollar terms these days, and it just broke its previous high at ~8640.
Recall: $GOLD = XAU/CNY divided by USD/CNY
It used to be XAU/CNY trapped in a tight range. Now it is USD/CNY’s turn. If XAU/CNY continues to rise and USD/CNY remains as-is, Gold in dollar terms will continue to rise. It’s simple math.
In summary, if Gold and the Dollar are anticipating a Fed reversal in policy, and XAU/CNY continues to rise while USD/CNY remains stagnant or even starts to fall, Gold may have already begun its meteoric rise. Time for the Bulls to party at last!
Well, hold on. Not quite yet. There are still quite a few land mines for Gold out there.
THE BEAR CASE
1. A Stock Market Rally
Gold may be anticipating a Fed reversal in policy, but what happens to those expectations if stocks rally without it? Gold may be increasingly correlated to the DXY on an inverse basis, but its inverse correlation to the S&P is far higher at -0.70 and also rising.
Stocks have fallen precipitously since hitting their all-time-highs and are extremely oversold, overbearish, and positively divergent. Bear market rallies can be violent to the upside. Such a rally now would catch everyone off guard, including buyers of Gold.
2. Technical Resistance & Momentum
Based on the front month future, December, Gold has still not broken out of its Bear Flag/Channel or its 200-day moving average. It is also extremely overbought per its RSI. Despite increasing bullishness, the risk is that it fails to break these levels and heads lower again, which brings me to the third point.
3. Silver lagging Gold
Although Gold can and often does lead the way at major turns in the precious metals sector, as it did in December 2015, it is not always the case.
Silver is still well below its 200-day moving average. Momentum is clearly lagging that in Gold, also based on its RSI. It continues to struggle to break out to the upside and, like Gold, is right at resistance here.
Worse, its higher closing high yesterday was negatively divergent per its RSI and MACD Histogram. On a standalone basis, this might not be an issue, but don’t get me started on Platinum, which is lagging badly behind both of them.
4. U.S.-China Trade War Escalation
Saving the biggest caveat of all for the Bull Case. Here is my view on the U.S.-China trade dispute in a nutshell…
We have had nothing but comic relief in the form of positive headlines, chats, meetings, group photos, détentes and great progress, followed by threats of further tariffs on all of China’s exports to the United States, and perhaps even higher than 25%. Nothing has improved. The U.S. continues to demand more action from China on the key issues, and China continues to play for time to wait out the U.S. until the S&P crashes.
I didn’t expect the détente to last until March 1 without both sides trading verbal punches, and I haven’t been disappointed. Cutting to the chase, there will NEVER be an agreement to U.S. core demands. Unless the S&P crashes first and the U.S. relents, there is a high risk of 25% tariffs being implemented and China responding by allowing “market forces” to push USD/CNY significantly above 7.
If the U.S. were to impose 25% on all of China’s exports to the United States, it is not unreasonable to expect the CNY to devalue by another 10% against the dollar. Unless XAU/CNY goes to 9000 or above, this means Gold is going back down, perhaps to lower lows.
Unfortunately, although the XAU/CNY has broken up to new highs this week, it has done so in a negatively divergent fashion, as can be seen from the RSI in the chart above. The risk is not that it goes higher from here, but lower. This means that any devaluation of the CNY before or after March 1 will likely mean lower Gold prices.
CONCLUSION
Although everyone is once again getting excited by the prospect of higher Gold prices (including myself), there is plenty of ammunition for the BEAR CASE also. At the end of the day, whether we go higher or lower in the next 0-6 months depends on whether we get a crash in U.S. stocks followed by a Fed policy reversal and subsequent decline in the dollar, before the U.S. increases tariffs to 25%.
The absolute worst case for Gold would be a Fed reversal in policy and the dollar goes higher—stocks too—and the U.S. proceeds with 25% or more in tariffs on all of China’s exports, before China pulls the plug on everything by significantly devaluing the yuan. However remote a probability this is, it is possible.
Long-term: Gold, Silver, and the miners are only going much higher. It’s just a matter of time, in my opinion.
| David Brady has managed money for over 25 years for major international banks and corporate multinationals both in Europe and the US, with experience in Bonds, Equities, Foreign Exchange, and Commodities In 2016, he created GlobalProTraders.com, an interactive online community for traders to share their views on financial markets. |
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