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The Macro Perspective
Precious metals have exhibited broad weakness in the past six months, seemingly contrary to what market conditions might suggest. In the midst of trade wars and Emerging Markets worries, they should – in theory at least – have performed better. But can we identify any fundamental reasons for that? Let’s take a step back and analyse gold’s price action from the global financial crisis onwards.
From around $600 in 2007, gold went on a parabolic rise to a peak of over $1900 in 2011, reflecting the worsening global economic conditions. Precious metals were one of the main “go-to” safe haven assets, and as such they outperformed most other asset classes. Interest rates were slashed and bond yields fell dramatically, while equities found some support after the initial drop in 2008. However, that parabolic rise was never going to be sustainable, and so a big drop started in mid-2011 for both metals. Silver in particular has now lost over 70% of its value from the peak, in a spectacular sustained drop.
What are the potential reasons for the precious metals moves?
The US Dollar has seen some strength since February 2018, with the DXY index in particular bouncing over 8% from the lows. Precious metals have always had a negative correlation with the Dollar (at least in the short term), and this has potentially been a reason for their weakness in 2018. Having said that, it’s worth noting that the Dollar weakened substantially in 2017 but precious metals didn’t manage to rally at all during that period.
Global inflation has been steadily rising towards the widely-adopted 2% YoY target. The US and Eurozone are now at target, while the UK has been well above 2% for a fair amount of time already. As a result, the Fed has been tightening rates for the past two years, and even the Bank of England hiked twice – despite the ongoing Brexit fears. On the other hand, the ECB hasn’t hiked yet but is expected to do so in mid-2019. While inflation is rising, so are rates, and it’s a well-known fact that PMs are sensitive to change in real rates (interest rate minus inflation). Real rates have in fact remained relatively constant at historically low levels, so effectively the argument that rising rates have damaged PMs doesn’t necessarily stand.
Supply and demand for gold and silver has been broadly constant over the past years, with gold in particular being extremely stable. Silver, being an industrial metal, has seen some fluctuation due to changing demand and advance in technology (for example, miniaturisation). However, the advance in technology also means that there are now more devices than ever which use silver, and furthermore its use in areas such as photovoltaics and medicine is constantly growing. So, one could say that natural supply and demand (i.e. non-speculative) has been relatively constant.
Global geopolitical events have been a source of volatility is most asset classes. Events such as the US-China trade wars, Emerging Markets chaos (Venezuela, Turkey and Argentina to name a few) and the ongoing Middle-East situation are valid reasons for flight-to-safety flows to PMs, but this has not materialised. In fact, actions such as Turkey’s decision to sell gold in order to support the Lira have been greeted as price negative. But is this true? When a country is in crisis, its first line of defence is often gold, with its steady value and liquid market. If gold was not a useful and valuable asset, surely it would be one of the last tools a country would use to defend itself. It’s probably safe to say that global geopolitical dangers are not the reason for PM weakness, in fact they should theoretically have provided support.
Money supply is directly linked to the price of PMs, given their finite supply and difficulty in extraction from the ground. The Fed’s and ECB’s slow reversal of their quantitative easing programs will reduce supply, but that’s just one part of the equation. The constant generation of deficits by all major western economies (with the US leading the way at nearly $1trn annually), more than counterbalances this effect and causes money & credit supply to continuously increase globally.
Bitcoin and other crypto-currencies have been hailed as precious metal “replacements” when it comes to finding assets that can be used as a store of value. Their convenience and lack of storage need need make them worthy alternatives for sure, and as such they have probably been adopted by many. On the other hand, they remain assets with practically no intrinsic value – they are simply digital assets that have been manufactured out of thin air, based on a specific computer code. This fact bears many dangers and has been a constant stumbling block for sceptics.
Speculative selling has been a much-heated debate when it comes to precious metals. Whenever gold and silver have tried to overcome major technical levels (such as the 200DMA in silver), they have been met with violent selling in the futures market, with no other obvious prevailing reason. The moves have been sudden, relentless, and very effective. These speculative selling flows have seemingly been the main reason for gold and silver weakness over the past few years.
So, what’s the possible macro direction going forward? Well, even though PMs have been particularly weak in the past few years, the reasons for that move are not totally clear. Fundamentals suggest that they are now substantially undervalued and should be close to a major turn. The Gold / Silver ratio is also flashing the warning light, as it has reached lofty levels which most often signify the beginning of a broad bull market. Silver always outperforms gold on a rally and with the ratio near 85 we’re getting a strong indication that the rally may be coming soon.
The Basic Technical Analysis Perspective
Two weeks ago, Gold had a mini “capitulation” in Asian trade that took the precious metal below $1160 before reversing aggressively the following days. And currently we are trading well above that low as Silver continues to grind out a new cycle/trend low. In the event Silver bounces, the risk for a gold rally is high. We have a bull flag from the lows and the RSI is also developing a bull flag formation. At this time, a break above the $1200 level in the spot price could cause a short squeeze towards the $1240 level, being the breakdown point which was the lows from December 2017.
Silver is depreciating within a descending channel after breaking below the L/T symmetrical triangle in the end of June but we are finally starting to see the first signs of divergence. The RSI reached almost 20 at the previous low ($14.30) but is currently above 30 despite the metal trading lower while at the same time gold is failing to follow silver lower and to register a new low (cross market divergence). We are watching $13.91 (the flash crash low) and $13.63 (the 9 year low) for support while a break above $14.50 and the descending channel resistance will indicate that a corrective bounce is underway. A breach of the 1st target brings $15.20 and $15.70 in the scope.
The Elliott Waves Perspective
If we ignore the lower time frame charts on gold, and focus on weekly timeframe instead, we can actually notice that metal did not make any clear directional movement since 2015. All what we see are big swings in $1050-$1400 range. Normally this type of a price action represents a correction rather than impulse. So if we want to understand in which direction market can break out once consolidation is done, then we have to look back to see where the market came from. Well, we can see a very strong five wave fall from above $1900 level; it’s called an impulse that represents wave A as only one part of a big decline from 2011 highs. So if we are on the right track, then a new drop below $1000 will follow, maybe later this year or at the start of 2019 once corrective wave B is finished that we see it making a triangle. This is a five wave pattern and ideally now in final piece of the puzzle; wave E which may see resistance at $1240-$1300 area. What should be important as well, it’s Dollar Index that is making a five wave recovery since January which means more upside on DXY equals to more weakness on gold. If you are a member of our ForexAnalytix service with an Elliott Wave package, then you exactly know what I am talking about.
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