viernes, junio 17, 2016

GOLD IS NOW READY FOR THE NEXT LEG UP / SEEKING ALPHA

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Gold Is Now Ready For The Next Leg Up

 
by: Andrew Hecht
 
 
- Bull market emerges in early 2016.

- An ugly correction.

- Open interest in gold points higher.

- Central bank junkies are addicted.

- $1400 next stop.
 

Gold is money. The lustrous metal is a means of exchange that has been a store of value for thousands of years. I traded gold since 1981 when the price was on the way down from all-time highs of $875 per ounce in 1980. I worked for one of the major international bullion dealers with offices all over the world, Philipp Brothers, and ran the precious metals trading desk from 1989-1997. For 27 years, gold never traded higher that the price in 1980. In fact, the price of the yellow metal traded in a range between $255 and $503 from 1981 until 2005.

During those years, the yellow metal became a very alternative asset. Many considered gold a barbarous relic. Gold fell so far out of favor that the United Kingdom sold half of their gold reserves at prices below $300 per ounce from 1999-2001. The British government sold the lows.

Gold was a dead asset for just shy of three decades until it made a new nominal high in 2008 and a new all-time high at $1920.70 in 2011. The amazing bull market in gold came to an end in September 2011, and it fell to lows of $1046.20 by December 2015.

Bull market emerges in early 2016

After trading to lows that were still higher than the nominal 1980 price during the fourth quarter of 2015, the price of gold took off in 2016. The year opened with a massive decline in Chinese equity prices that reverberated around the world causing uncertainty. Gold came out of the gate and charged higher. Even while many other commodities continued to make new highs, the price of gold surged. By February 11, when crude oil traded at the lowest price since 2003 at $26.05 per barrel and copper had just made lows below $2 per pound, gold was trading at over $1200 per ounce.

   

As the daily chart of COMEX gold futures highlights, August gold traded up to highs of $1263.60 from lows of $1200 on that fateful day in February. Gold was over $217 higher than the December 2015 lows signaling something special for the commodities sector.

The yellow metal continued to move higher. By May 2, it was trading at highs of $1306 -- an increase of 24.8% from the 2015 lows. Gold rallied for three important reasons. Global interest rates remained at historical lows even after the first rate increase by the U.S. Fed in December 2015. The dollar turned south in 2016, and weaker dollar provided support for the precious metal. Finally, gold acted as the ultimate safe-haven asset during a year where the overriding theme has been uncertainty.

While gold rallied dramatically, the returns in gold equities were even more spectacular.

Last month, the dollar rallied, and at the same time, gold corrected lower.

An ugly correction

The selling began when gold traded over $1300 for the first time since the week of January 20, 2015.

That week, the yellow metal peaked at $1307.80 per ounce. In May gold came within $1.80 of those highs, but it just could not make it.

Over the weeks that followed the $1306 highs, gold declined steadily reaching lows of $1201.50 on the August COMEX futures contract on the final day of May. Gold seemed poised for further losses; the dollar had just completed a very bullish technical pattern. The dollar index traded to a lower low in May than in April and closed above the April highs marking a bullish key-reversal trading pattern on the monthly chart. A bullish signal like this tends to cause a market to follow through to the upside. However, one worrying factor about the move in the dollar index was that it was accompanied by low volume and falling open interest, the total number of open long and short positions on dollar index futures contracts.

  

The monthly chart of the U.S. dollar index futures contract clearly illustrates the bullish key reversal. However, when one looks at the data closer, volume for the month was only 413,024 contracts, in April, the dollar index traded a total of 489,956 contracts. In April, open interest stood at 70,256 contracts but in May, it fell to 62,195. A decline in volume and open interest at the same time did not provide technical support nor did it offer validation for very bullish price action. The confusion was clarified when the dollar tanked after the May employment report was released on June 3 negating the bullish signal.

  

The daily chart of the U.S. dollar index shows that the greenback proceeded to make a bearish key-reversal trading pattern on the daily chart on the day the employment report came out.

The chart shows an increase in both volume and open interest on the daily bearish signal and the dollar index has followed through to the downside, falling from highs of 95.96 on May 30 to close last week at the 94.561 level on the active month June contract, the dollar rebounded at the end of last week on growing worries about the Brexit vote and a positive weekly employment report.

While the dollar reversed and moved lower, gold recovered dramatically and the May correction wound up being healthy for the technical position of the yellow metal. Even as the dollar gained at the end of last week, gold moved higher.

Open interest in gold points higher

The dramatic rise in the price of gold in 2016 caused an over exuberance among speculative longs who hopped on board the gold express train before May. Even after gold peaked on May 2 longs continued to buy and open interest rose to 596,513 contracts on May 16. That was the highest level since 2010 when gold was on its way to all-time highs in 2011. Gold open interest peaked at 612,454 contracts in September 2010.

During the second half of May, gold picked up downside steam as the descent to $1200 continued.

 

As the daily chart shows, a massive decline in open interest accompanied the correction in gold.

Gold dropped a total of 8% from the highs, but open interest fell to 481,096 contracts by June 2, a decrease of over 19%. Speculative longs ran for the hills and closed risk positions as the price of the yellow metal sank. A rising dollar and falling open interest turned out to not be supportive for more gains in the greenback. Falling open interest and price turned out to be bullish for gold. The bottom line, weak longs exited the market, and now gold has a lot less speculative froth in the futures market. The move in gold was healthy, and fundamentals are poised to take the precious metal higher.

Central bank junkies are addicted

Like a bunch of crack-heads looking for their next high, the central bankers of the world have become addicted to stimulus. For the past eight years, lower interest rates and quantitative easing or the purchase of debt inflating central bank balance sheets has become the norm rather than the exception when it comes to monetary policy.

Interest rates are negative in Europe and Japan, and those economies continue to be sluggish.

Recently, the President of the ECB appealed to governments in Europe that the Central Bank cannot improve the economy on its own. He urged governments to enact policy initiatives to accompany the central bank steroids of free money and a free put option on debt. In the U.S. we had a dramatic lift-off from zero interest rate in December with the promise of more hikes to come in 2016. We have heard lots of jawboning from the Fed regarding their intention to eventually increase rates, but when it comes to action -- all we have heard is the sound of crickets.

A drug habit is very hard to break. The stimulus addicted central bankers of the world need to take stock and understand that a continuation of flooding the system with paper currency does nothing but decrease the value of the money that only has the full faith and credit of the government's that print it as backing. Increasing interest rates before it is too late and inflation creeps into the global system is the necessary medication but the only medicine a junkie desires is more of the one that is the source of their addiction. For the world's central bankers, stimulus provides their daily high, and they continue to accommodate their habits.

$1400 next stop

I believe that gold, the ultimate currency that central banks can never print more of, is telling us that inflation is back and over recent months other raw material prices are telling us the same thing. The price of crude oil has almost doubled since February and grain and other agricultural commodity prices are rising fast.

  

The monthly gold chart points to a continuation of bullish momentum. Now that gold has purged itself of the speculative froth of over-exuberant longs, it is preparing to move above the May 2 highs. My target on gold is the August 2013 highs of $1428 per ounce in 2016.

Gold will not rally in a straight line, however, the fundamentals for gold, precious metals, and other commodities have all improved as central bankers refuse to back off accommodative policy. It is probable that we will see the yellow metal work its way up to above $1400 as it is the one currency that only occurs in the crust of the earth. No one has figured out a way to produce gold using ink and paper. Gold is prepared for its next leg up, buy any price dips and hang on for a wild ride. Gold closed last Friday at the $1278 per ounce level on the August COMEX futures contract.

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