The gold price has dropped $40 or more than 3% over the past week from $1,255 to a low of $1,215. Silver has shed nearly $1 or 5.4% from $18.40 to $17.40. Sentiment has turned bearish and many analysts are now calling for precious metals to decline to new 2017 lows in the days and weeks ahead.
Fear the FED?
The main driver of the drop in the gold price has been a dollar rally, driven by increased odds of a March rate hike. Several FED officials have made comments suggesting they are ready to hike rates at the March 15 meeting. The odds of the FED hiking rates in March increased sharply from around 40% to 75% in a matter of days following their comments. Those odds have continued to inch higher, now pretty much at 100% probability of an increase in interest rates.
Slowly rising interest rates coming off a base around zero are not bearish for gold prices. Gold gained 52% in the June 2004 to June 2006 tightening cycle. It is also worth noting that precious metals initiated massive rallies immediately following the last two Federal Reserve rate hikes in December of 2015 and 2016. A hike of 25 basis points appears to already be baked into prices. If the FED fails to hike for some reason, watch for gold and silver to rocket higher. With the FED, you can always expect the unexpected.
Spring tends to be a weak seasonal period for gold and silver, but also one of the best times of year to buy. So, fear not the rate hike and instead exploit the unfounded fears of others to pick up precious metals on the dip and mining stocks at deep discounts.
Commercial Paper Shorts Pile On
Another factor that is no doubt weighing on gold and silver prices is the huge increase in short positions on the COMEX by commercial traders. Silver in particular now has the largest short position in history by commercial traders. This is often a precursor to a massive drop in the price, as commercials tend to be “smart money” (big banks with the means and leverage to manipulate prices).
The blue bars show the short positions by commercial traders, which you can see has increased to record levels as of the last COT report on March 3rd. The next report will be released on March 10th, which will give us a better idea of their position against silver. The gold chart also shows an increase in commercial shorts, but not nearly as dramatic as it occurred in silver.
On the flip side, large short positions also have the potential to add fuel to the fire of any rebound, as shorts would have to scramble to cover the positions. Given how large these positions have become, that is a significant amount of buying that would need to take place to cover. It remains to be seen just how committed they are to their bet on lower gold and silver prices.
Divergent Tops and Bottoms
We sent a note to subscribers last week when gold and silver started to climb higher, but mining stocks did not lead. This type of divergent top is almost always bearish and prices did reverse course in the days following this signal. Not only did mining stocks fail to lead the metals, but silver failed to lead gold higher. We ideally want to see these conditions present in order to increase our confidence in any move higher.
More recently, we have seen the opposite happening. Gold and silver were down 0.8% and 1.6% today, yet the GDX was only down 0.6% and GDXJ was actually in the green by 0.8%. We would normally expect to see mining stocks leading the metals lower with leveraged declines. Could this divergent bottom be a bullish sign for the sector?
Gold Technicals Are Neutral
The technical chart for gold is neutral from my perspective and does not yet suggest a major move in either direction. On the bearish side of things, the long-term downtrend that started in 2011 remains in place. The advance in 2016 was powerful, but not strong enough to break above of the downward-sloping trend channel.
But the shorter-term trend channel (dotted lines) is largely bullish. The advance in 2016 interrupted the series of lower highs and lower lows that had been taking place for years. Instead, gold has experienced a few higher highs and higher lows over the past few years. The 50-day moving average has crossed upwards through the 200-day moving average, which is another bullish sign.
Gold is holding right around support at $1,220, which has acted as both support and resistance over the past few years. I think this support will likely fail over the next few days and gold will test $1,200. From there, all eyes will be on $1,140 and bulls will want to see gold bottom somewhere above this price level to remain long for the remainder of 2017.
The bottom line is that gold is currently directionless. We can’t project the direction of the next move with any confidence until gold breaks decisively below $1,140 or above $1,300. The current price of $1,220 is directly between these two key price points, so a move higher or lower has roughly equal weighting.
A break above $1,300 would be very bullish as gold would break through and invalidate the multi-year downward-sloping trend channel. A break below $1,140 would make a lower low on the chart and invalidate the short-term upward-sloping trend channel in place since late 2015. The RSI momentum indicator is in neutral territory with plenty of room to run in either direction.
With the above conditions present, we believe it is best to remain on the sidelines with plenty of cash available to take advantage of a potential dip in prices. The Gold Miners ETF (GDX) has already corrected by 15% and the Junior Gold Miners ETF (GDXJ) is down 20% since topping in early February. I would not be surprised to see a bit more downside from GDX to support just above $20. However, it is worth noting that the RSI is very close to oversold levels. A relief rally could be in play as early as Friday.
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