Don’t try to Pick Up Pennies in Front of a Steamroller - David Brady (18/10/2019)

October 18, 2019

SHORT-TERM

GOLD

Starting with my perception of the current Elliott Wave count: I believe we’re in wave ii down of (3) of 3. If this is the case, then what follows is the money wave, wave iii of (3) of 3.

We may have already hit the wave ii bottom, where C = A at 1465, and we’ve already begun wave (i) and (ii) of iii. But given the lacklustre rise in Gold so far, I’m leaning towards the Alt ii / wave C bottom being 161.8% of A in the low 1420s and then we take off in wave iii.

What we can say for sure is that Gold has completely erased the overbought and extreme bullish condition at the peak of 1566. The RSI has dipped back below 50 and both MACDs are negative. This sets us perfectly for the rally to follow, as does the bull flag pattern we’re seeing on that chart.

That said, the 20-day exponential moving average has crossed the 50-day simple moving average to the downside for the first time since wave (2) in March, and flag structure allows for a lower low yet to the 1420s should Gold choose to follow that path.

In summary, either we have already bottomed or we have one more leg down to the 1420s before Gold takes off again. I am not in the business of picking up pennies in front of a steamroller and have already started adding to my position in metals and miners. Only a drop below the wave (1) peak at 1350 would give me cause for concern.

The weekly chart also supports a lower low yet, given how far we had come on the latest rally. The weekly RSI and MACD Line hit their highest levels since the peak in 2011. With the RSI hitting a low of 61, it still has room to fall further, as does the MACD Line.

If we do break 1340-50, then the worst-case scenario becomes a greater possibility, where we head down to lower lows below 1045. It would require a drop below 1167 to become a realistic probability, hence I keep that on the top shelf gathering dust for now.

SILVER

It is no surprise that Silver is showing a similar profile to Gold. It, too, is in a bullish flag pattern. Its 20-day EMA has broken its 50-day SMA. It is in an ABC wave ii down from its peak at 19.75. It may have already bottomed at 16.94 or still has work to do on the downside to 16.50, where C = A. Again, I’m leaning towards the latter.

I also show the worst-case scenario in red on the chart in the event that we break the wave 1 peak at 16.20 and are heading down to lower lows. Like Gold, this is a low probability event at this point in time.

The weekly chart shows the RSI has fallen to just 64 after hitting a peak of 84, its highest since April 2011, when it reached 89. I would prefer to see at least a 50 handle for the bottom.

SILJ – JUNIOR SILVER MINERS

Given my belief that the bull market in the metals and miners began in December 2015, I have clearly stated my preference for Silver over Gold in terms of the gains going forward. This is especially true with respect to the miners, and the juniors in particular. My favoured vehicle in this regard is SILJ, the ETF for junior miners.

Focusing on the weekly chart to avoid the daily noise in a relatively illiquid ETF, it paints a pretty picture, imho. Unlike the metals, we can see a clear 1, 2 wave structure since its bottom in January 2016. Wave i of 3 peaked at 11.56, a perfect 61.8% retracement of the wave 2 drop from the 19.32 peak in August 2016.

Wave ii may have already bottomed at 9.12, a 50% retracement of wave i. Alternatively, the 61.8% level is at 8.59. Just below there is the July low at ~8.33.

The 70-day simple moving average is also a key level to watch. After holding as support in March 2017, it broke down below it the following month and never closed above it again until July this year, despite having tested it approximately fourteen times in the interim. When it did finally break it in July, it shot through it, emphasizing how important that moving average is. It is now acting as support at 8.93.

Whichever level turns out to be the bottom, wave iii of 3 is due next if this scenario holds true. Given that we got a 70% gain in wave i and a near 500% jump in wave 1, it promises to be spectacular. It also supports the view that either the low is in for Silver and Gold or it’s close.

BIG PICTURE FUNDAMENTALS

I cannot finish an article on metals and miners without commenting on the Fed’s recent shenanigans, their impact on real yields, and what it means for Gold, Silver, and the miners beyond the near term.

The Fed decided not to wait for the October FOMC meeting to announce the plans to stabilize the repo market, which had seen rates skyrocket recently due to illiquidity issues. That speaks to just how fragile the system is. There is a lot of debate about whether this is normal open market operations or QE. My take is that it is the latter, given that the Fed is printing money out of thin air again to buy U.S. Treasury securities and expanding their balance sheet. The amounts are similar to QE1, also.

There is also debate with respect to the cause of the spike in repo rates, but the response reinforces my belief that soaring Treasury issuance due to exploding government deficits and debt, new and rollovers of maturing debt, were the cause. With foreign buyers being net sellers since at least 2016, when U.S. deficits began to soar again, domestic banks and money market funds had to pick up the tab. They are the main providers of cash—i.e., liquidity—in the repo market. Given the amount of bonds or collateral being offered in return for cash, the cash lenders ran out of liquidity. How do we know this? Their excess reserves plummeted over the past year. This is why the Fed emphasizes the need to increase those reserves again, to avoid stress in the repo market and in the banking system itself. How are they doing it? They’re buying T-Bills and other short-term Treasury bonds. This is a backdoor method to execute QE-lite, because government debt is overwhelming domestic buyers. This is just the beginning, in my opinion.

Why aren’t Gold and Silver taking off as a result? The Fed is focusing their efforts on the short end of the yield curve, compressing repo rates to keep them in line with the Fed Funds rate. Simply put, they are reasserting their control of the price of money, via the Fed Funds rate, by their own admission last week. This frees up liquidity for banks to put money to work in equities. Now we’re seeing funds flow out of longer dated bonds, such as the 10-Year Treasury (“10Y”), and into equities, which pushes down long bond prices and pushes up yields. As a result, the 10Y has risen almost 30 basis points from 1.51% to 1.80%, a 20% increase in just nine days for boring old bonds. A massive move, especially when almost everyone was looking for lower yields given the awful economic data recently, which began with the ISM on October 3.

With inflation expectations relatively stable, real yields, which are basically nominal yields less inflation, began to rise. Real yields rose from zero pre-market on Monday, October 7, to a high of 19 basis points this week. They had bottomed at minus 9 basis points back on August 29. Gold peaked three days later at 1566. Silver, too, at 19.75.

When real yields rise, Gold and Silver fall. I don’t know if this will continue or not, but it could, which would weigh on the metals “in the short term”. However, I don’t buy the “This is NOT QE” argument. This is just the beginning. What will spark full-blown QE? Either a crash in the stock market or a spike in bond yields that forces the Fed to intervene in a big way to avoid collapse of the ‘Everything Bubble’. They have no choice.

Keep this in mind: they increased the Fed’s balance sheet 5x since 2008, from 900 billion to 4.5 trillion dollars. Given the law of diminishing marginal returns, how much will they need to increase it next time? 6x? 8x? Assuming it is just another 5x, that would put the Fed’s balance sheet well north of $20 trillion. Basically, the entire national debt. Sound crazy? Unfunded liabilities start to come due in a big way next year, and that is six times the national debt. With the Fed monetizing government debt in such a massive way, when is confidence lost in the dollar? When do the voters start screaming for MMT? Ahead of a 2020 election perhaps? Several of the Democratic candidates are already discussing it openly.

The point is that the Fed has reversed from rate hikes and QT to rate cuts and QE, and it’s only a matter of time before they revert to “monetary insanity on steroids” as I call it, ultimately leading to MMT and UBI (Universal Basic Income), also known as helicopter money. Where do all those dollars come from? Printed out of thin air. When that happens, Gold and especially Silver will explode higher, imho. The Fed just fired the starting gun. Whether we have already bottomed in metals and miners remains to be seen, but does it matter? Don’t try to pick up pennies in front of a steamroller.

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