By Pater Tenebrarum at Acting Man blog
We could make that little list above a lot longer. Just two or three weeks ago, SocGen lowered its gold price target to $850 for instance. In fact there is a bearish mainstream sell-side consensus on gold now that is more pronounced than the bullish consensus was when gold traded between $1,600 and $1,900.
If proof was ever needed that listening to these guys when they are all of one mind can be injurious to one's wealth, the gold market has provided it in spades in recent years. Almost the entire mainstream missed the bulk of gold's run from $250 to approximately $1,300. There was the occasional small nod toward the bull market, since it could not be ignored completely, but this was always tinged with the idea that it could not rise much further (there were occasional exceptions). For instance, gold price assumptions made in estimating the future earnings potential of gold miners always assumed lower gold prices in the future, and for 12 years running, these assumptions turned out to be wrong.
However, once gold rose above the $1,500/$1,600 level, a real crescendo of mainstream bullishness was suddenly in evidence. The very same analysts who are to a man bearish today, were almost to a man bullish at higher prices.
Naturally, one is always free to change one's opinion if the fundamental backdrop changes. The point we wish to make is only this: it is definitely a contrarian sign when all these guys are singing from the same hymn sheet, regardless of their purported “reasons”. They have e.g. been bullish on the US dollar for more than a year now. And while the dollar index hasn't gone down much, it sure hasn't shown the slightest inclination to make any of these bullish forecasts come true either. The consensus is equally consistently wrong about the bond market. At the beginning of the year, there was a bearish consensus on bonds so thick, you could cut it with a knife. T-bonds promptly embarked on a big rally.
There has been one market on which the perennial bulls on Wall Street have been right in recent years, and that is the stock market. Given that the money supply has nearly doubled since 2008, they had plenty of help. Over the past century, the stock market has risen 67% of the time, which is a direct result of incessant monetary inflation. Anyone who is always bullish on stocks can expect to be right two thirds of the time. That is a lot better than a coin flip. Of course this also means that one misses the major turns (both at major peaks and major lows the consensus is always wrong. The only time when Wall Street strategists become collectively bearish on stocks is right at major lows).
We are actually of the opinion, and we state this with a confidence that is by now almost bordering on certainty, that the stock and junk bond markets are the next candidates for dispensing a kick into the groin of the happy consensus (we will shortly take a closer look at how crazy things have gotten over just the past few weeks in those markets).
As an aside to this, there exists very little mainstream gold analysis that makes much sense (although this has ever so slightly improved in recent years). Anyone focusing on ETF flows, mine production, jewelry demand, etc., simply does not understand the gold market, period.
This brings us to the current situation. The battered gold bulls have just won a skirmish, and it may well have been an important one. Ever since gold broke down from its triangle in May – a seemingly very bearish event – we have chronicled the emergence of more and more signs that were warning of a pending reversal (see: “A Few Signs of Life in Gold-Land”, “Gold Outlook Improves” and “Gold and Gold Stocks – Looking Even Better” for the details).
While there was of course always the caveat that more patience may be needed, we personally felt that a bottoming process was underway. What has happened after the FOMC announcement must actually count as a very bullish development (hence the title of this post) from a technical perspective. Simply put: there are few more reliably bullish signals than a technical breakdown that fails and is followed by a reversal. Of course, there is plenty of resistance that still needs to be overcome, the seasonally weak period is not yet over, etc.,etc., but we would argue that any near term pullbacks in gold and gold stocks must be regarded as opportunities at this point. Of course it is always possible that the “negated breakdown” was yet another fake-out – it is just not very likely.
Skepticism Still Abounds
Interestingly, headlines in the press show that the reversal in precious metals is meeting with a lot of skepticism. Here are a few examples from today:
“NY Trader (via Bloomberg) – Gold Spikes on ‘Massive’ Hedge Fund Short Covering in NY Spot gold touched $1,322.12, strongest since April 15, partly on buying led by leveraged accounts that included hedge funds, according to an FX traderbased in North America.
Gold Spike Yday May Be Related to Quadruple Witching: BMO
Yday’s 3.3% spike in NY gold futures to $1,314/oz “may simply be a function of closing out or rolling over large futures and options positions” that are part of today’s so-called quadruple witching, when four futures, options contracts expire, writes BMO technical analyst Russ Visch in note. He notes last “dramatic spike” in gold in March was during that month’s quadruple witching, after which gold retreated from nearly $1,400 to $1,240/oz. Says long-term downtrend in gold is “probably not” over. Watching for 200-DMA to turn higher, which wold increase the chances that a bottom is in.
SMRA – Be Skeptical Of This Gold Rally
Make no mistake; the latest data from the CFTC regarding Commitments of Traders reveals nothing to suggest that there was a cathartic level (i.e., a contrarian extreme) of disdain toward gold at the late May/early June lows. For this reason, we think the gold market lacks the psychological foundation for the recent rally to be the start of a major turnaround. Instead, as the chart below shows, gold is rallying as part of a predetermined pattern (triangle), with the primary source of inspiration for the late May/early June reversal being the yellow metal's extreme undervaluation vs. equity prices.”
It is certainly true that the rally was sparked by short covering. As we related recently, “managed money”, which is a separate category in the disaggregated CoT report, has massively increased its gross short positions in both gold and silver, especially relative to the short positions it held at the peaks in 2011 and 2012. In fact, these positions have reached rarely before seen extremes (see the next chart).
However, every rally in the futures markets begins with short covering by speculators. In other words, the fact that the current rally has done the same is not really telling us anything. What is telling us something is the fact that the fundamental backdrop for gold has turned slightly more bullish in recent months. For instance, as a result of the rally in treasury bonds, credit spreads have widened. At the same time, market-based inflation expectations (as evidenced by inflation-protected vs. nominal bond yields) have increased somewhat.
Note in this context that we will soon publish the new Erste Bank/Incrementum “In Gold We Trust” report (next week), which contains extensive deliberations on the fundamental backdrops and goes into a lot more detail.
Short and Long Term Outlook
In the short term, both gold and gold stocks are surprisingly already overbought, and probably due for a pullback. Where this pullback stops will certainly be informative. Ideally, gold should not fall below the above shown triangle apex again. We don't believe it will, but obviously we cannot rule anything out apodictically.
In the long term, we see two major possibilities for why the price trend in gold could turn bullish again. We mentioned one of them in yesterday's update on the FOMC:
“Interestingly, the gold market has rallied on news of the continuation of 'tapering', and as we have remarked previously, we believe this is due to the gold market exhibiting an extreme lead time in discounting future economic developments as well as the monetary policy decisions they will eventually provoke (whereas the stock market has become a coincident or sometimes even slightly lagging indicator of the economy).
What the market in our opinion sees, is that sooner or later, 'tapering' will lead to a crash or at least a mini-crash in the asset price bubbles currently underway, whereupon the central bank will either resume 'QE', or implement some other monetary pumping measures by way of experiment.”
However, in light of recent developments on the “price inflation” front, there is a second possibility worth considering. As we also pointed out, there is currently a broad consensus among economists – including Fed chairwoman Yellen – that the recent acceleration in CPI is just “noise”. We are inclined to agree up to a point, at least insofar as we do not expect a major acceleration in CPI that actually sticks – at least not yet. However, what cannot be ruled out, is an acceleration that at the very least suggests to the markets that the Fed is “behind the curve” as the saying goes. We believe that this could become a major quandary for the central planners in coming months, and our sense of the situation is that they will continue to regard any further increases in CPI as “noise” and won't adjust monetary policy very quickly.
This would however lead to real interest rates falling deeper into negative territory, and it simply cannot be ruled out that this is what the gold market is attempting to discount. It is definitely possible that Ms. Yellen's comment about the rise in CPI representing “noise” has been one of the triggers for the sudden rally.
In any case, we would summarize the situation as follows: we remain long term bullish on gold regardless of what happens in the short term. While the short term is notoriously more difficult to forecast and we could well turn out to be wrong, we also believe at this juncture that the short to medium term picture is now turning bullish. With respect to the shorter term time frames, we are mainly guided by the technical and sentiment backdrop.
Below is an update of the chart we posted first on June 2, which shows why be believe that there is also a good technical reason for adopting a constructive medium/long term stance:
The red vertical line indicates the date when the original version of this chart was posted. All annotations in blue were made at the time. New annotations have been added in green – click to enlarge.
There are two important messages in this chart: most recently, the improving relative strength in mining stocks. Longer term though, it is the “double divergence” between gold and silver prices that is relevant. We have seen similar divergences at both the 2000-2001 lows as well as at the 2011 peaks. Such divergences almost always have longer term significance.
Lastly, there is also a long term divergence evident between prices and cumulative cash flows in the Rydex precious metals fund. This is by the way the last time we will show the Decisionpoint version of this chart, as the site has finally closed down. Luckily, the data will however continue to be available via Stockcharts (the two sites have recently merged).
Rydex precious metals fund: a divergence between prices and cumulative cash flows – click to enlarge.
The fortunes of the precious metals finally seem to be changing for good. As always, there are caveats, as many resistance levels remain to be overcome. Even if we are correct and a new rally phase has begun, be warned that it isn't going to be a smooth ride. We recently showed the 2000-2002 chart to illustrate among other things how extremely difficult the market makes it for bulls to hang tight even when it moves in their favor. Gold and silver are notoriously volatile, and gold mining stocks are even more so. One needs to be aware of this and must adapt to it. However, we have little doubt that the long term bull market remains intact. Note in this context that during the 1960-1980 bull market, there were two corrections that entailed declines of approximately 70% from the respective peaks in gold stocks. In spite of these huge declines, they eventually took off again like scalded cats and went far above their previous peaks. Bulls were just as discouraged at the lows in that time period as they are today. Obviously, this cannot guarantee anything, but it is a reminder that it is normal for gold bull markets to exhibit far greater volatility than other bull markets. It is simply the nature of the beast.