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Gold Prices Shine in the Race to the Bottom

Gold Prices Shine in the Race to the Bottom

2016-02-04 20:28:00
James Stanley, Currency Strategist
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Talking Points:

  • Gold Technical Strategy: Long, four targets cleared, one remains at $1,161.51. New conditional long setup identified (buying support, not chasing).
  • With Mr. Dudley of the Fed providing a dovish tilt towards US rate hikes in 2016, the bid in Gold has grown stronger.
  • As we near this critical juncture for the global economy, there is a strong chance that we’re going to see Central Banks around the world attempt to avoid a stronger currency in the effort of avoiding recessionary forces from distortions in trade balances. This is a positive for Gold if it continues.
  • Just because there is huge volatility here, it doesn’t mean that you should abandon your rules. If your risk management is not on-point, you are running the risk of ruin when trading Gold in an environment such as this. To get risk management tightened up: Traits of Successful Traders.

The past seven weeks have been peculiar for financial markets. We had the rate hike from the Fed, and that seemed to go off without too large of a hitch, at least initially. And then as we opened the New Year many of the fears that were circling under the surface to finish off 2015 came screaming back to the top of the headlines, and things haven’t really been the same since. We just saw a break of a long-term downward sloping trend-line, and it appears that a larger reversal may be afoot.

Gold Prices Shine in the Race to the Bottom

Created with Marketscope/Trading Station II; prepared by James Stanley

The scourge of financial markets has become that question as to whether or not we’re at the forefront of a global recession. This is a really difficult question to properly answer, and even if we could – a recession isn’t technically a ‘recession’ until we have two consecutive quarters of slower growth. By then, it’s often too late, at least if you’re a trader looking to trade a swing. By the time evidence of an actual recession comes in, at least in many cases, the big move has already been made.

But again, this is a really tough question to answer; is the global economy headed for a recession? And even if you could answer it – it doesn’t mean that you’ll be able to profit from it because by the time you ‘know,’ it will probably be too late. This is where the chart comes in. We can plan trade scenarios around these possible events, and then institute the strategy if the environment lines up in a manner that agrees with our assessment.

A necessity here is boiling down facts that we know, for certain, in order to separate from our speculations. And just yesterday, Mr. William Dudley of the New York Fed gave us another fact with which we can use in our planning around moves in Gold. Mr. Dudley provided some very dovish commentary in pertinence to the US Dollar. He essentially noted that a higher-rate spectrum in the United States would likely lead to USD-strength; which, in-turn, would put pressure on US exports, potentially even exposing the US economy to the same recessionary forces that are being felt around the world right now.

The near-immediate response was one of significant USD weakness, as previously this was one of the few currencies that caught a bid on the back of the expectation for higher rates. There were a ton of long bets in the US Dollar because Japan just went negative, Europe just went even more negative and it’s looking increasingly like we’re going to see some element of devaluation of the Yuan out of China. This means that there would be a lot of capital looking for a home, and this is not a good thing. If all of that capital rushed into the US Dollar as the Fed continued to walk towards and speak-up the four-rate hike in 2016 theme, the US Dollar would likely get so strong that US exports would take a hit. And that hit would come at an already precarious juncture, as these other issues in Asia and Commodities are in the process of presenting a whole other set of risks.

To boil this down: No major central bank appears to be wanting of strength in their currency, as it will just make their job of managing monetary policy even more difficult, and perhaps even impossible, as rampant capital flows can lead to further distortion in trade flows; distortion that, if left unchecked could pull that economy into recession along with the rest of the world.

This has traditionally been a good time to look at Gold as the prospect of further monetary debasement becomes a realistic prospect as major Central Banks all look at ways to stem currency strength. And this syncs with what we’ve been watching in the Gold market over the past couple of months. At the end of November and moving into the huge batch of Central Bank data we had for December, Gold was running lower in an aggressive down-trend that offered quite a few selling opportunities. Throughout the first half of December, Gold prices chopped around while trying to seek out a bottom, and just ahead of the December Fed meeting we warned against selling bottoms. The trend hadn’t yet flipped to the up-side, but this was enough to avoid pressing short positions. And then just before year-end, we looked at the prospect of a new trend in Gold prices.

Chop + higher low often preludes reversal in down-trend (prior image from 12/28/2015)

Gold Prices Shine in the Race to the Bottom

Created with Marketscope/Trading Station; prepared December 28, 2015 by James Stanley

A couple weeks into January and the top-side reversal setup was ready. But this was not without fraught, as is the case with most reversals. Price action moved aggressively as sentiment flipped, and that position came a nickel away from being stopped out at $1,071.28. Since then Gold has cleared out four targets and only one remains at $1,161.51.

The reason for pointing this out is to highlight how important technical analysis can be in such situations. All of these reasons and narratives didn’t become obvious until after-the-fact, and that is often going to be the case. Just like spotting a recession isn’t technically possible until we’re already in one, finding the reason for a price movement isn’t going to be glaringly obvious until after the fact.

But the chart illustrates where people are willing to put their hard-earned money to work. And when people are willing to chase higher prices in Gold, there is probably some type of reason for it. Now that we have this recent innuendo, it’s become rather clear that Gold is trading as a type of anti-currency. As in, the term ‘anti-Dollar’ became a popular catch-phrase for Gold given that gold is priced in USD (so USD moves up, Gold down and vice-versa); but looking at the movement that it put in last week after the Bank of Japan’s surprise move to negative rates, it’s clear that this is more than just a USD-play; it’s become more of an overall monetary debasement theme. As inflation looks less and less likely, and as Central Bankers make moves to avoid currency strength, this could bring continued flows into Gold as there is a lot of capital looking for a place to go. If you’re a Japanese retiree or a European investors, the idea of keeping cash ‘safe’ and tucked away just became that much more daunting.

And in such situations, price action can be violent. There will be swings. Stops will be hit, this is just the nature of the beast when trading in volatile markets like Gold. This is also the reason to look to techs for your setups, to ensure that your ideas and stories sync with what the market is doing at the time, and to enable you to move forward in a risk-efficient manner.

On that topic Gold is really strong right now on the short-term charts. Longer-term, that bigger picture downtrend has come into question as Gold prices have popped higher through that nearly 3-year old trend-line. But that doesn’t mean that you want to abandon prudence. This merely means that opportunity may be about. On the chart below, we look at some potential levels of relevance based on recent price action.

Gold Prices Shine in the Race to the Bottom

Created with Marketscope/Trading Station II; prepared by James Stanley

Since we have an up-trend with the legitimate prospect of continuation, the trader’s stance should be to look for ways to buy to get on the right side of that trend. The issue with current price action is that prices are still elevated. So, if you buy here you run the risk of chasing. Instead, you can wait for a better entry. I’ve attached two support levels to the above chart, and each of these can be long re-entries. The more aggressive swing is in the $1,140 area, and just below that we have a Fibonacci level at $1,127.03. Either of those could suffice if support builds on the hourly or 4-hour chart.

Profit targets in that case could then be cast towards $1,161.51 (38.2% of the prior major move), $1,189.39 (the 50% retracement of that same move), and then $1,200 (major psychological support/resistance). Should that become eclipsed, $1,217 could then become a level of interest as the 61.8% retracement of that same prior major move.

--- Written by James Stanley, Analyst for DailyFX.com

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