Extreme Sentiment In A Quiet Week Risks Trouble

July 3, 2020

FUNDAMENTAL BACKDROP

Short-Term Risks

• Fed is tapering its liquidity injections and the balance sheet is actually falling.
• Trade war between China and the US is escalating.
• Risk of a Wave 2 of COVID-19 and renewed lockdowns, crashing the economy and stocks too in the short-term.
• Bankruptcies accelerate across all sectors.

Medium/Long Term

• Fed will turn on the currency spigots again when stocks fall and, or bond yields rise. They will cap bond yields putting a floor under Gold and Silver.
• Combined with more fiscal stimulus ahead of the November elections, this is likely to lead to stagflation, the ideal condition for precious metals and miners - the 1970s on steroids.

SENTIMENT

The last time people were this bullish was in February and March, which saw peak-to-trough declines of $128 and $253, or 7.6% and 14.8%, respectively.

Silver is its most bullish since September 2019 when it peaked at 19.75, a level we haven’t seen since.

If that weren’t enough proof that almost everyone is bullish, then take a look at the gold miners bullish index today…

Yes, it reached 100%. By definition, that means everyone is bullish. The index can’t go any higher. The last time that happened was July 2016. You can see on the chart above what happened next.

Although the trend in both metals is clearly up and sentiment can remain extremely bullish for quite some time, peaks in bullish sentiment are much more often than not associated with peaks in price. Even in the bull market from 2001 to 2011, we got such extreme sentiment readings and prices under went significant reversals within the uptrend. The point being that the overall uptrend can continue but with meaningful intermittent drops, especially when sentiment is so extreme. This is why I recommend caution here. I am not shorting anything here but there is nothing wrong with taking some gains off the table or hedging your bets.

TECHNICALS

Gold remains negatively divergent at these recent new highs on a daily basis. Last week, I showed how extreme overbought the monthly momentum indicators were, with the RSI at its highest since 2011. Focusing on the weekly chart, we would need to see a sharp move higher to a new all-time-high to break the multiple negative divergences. The last one in March led to a $250 drop in just 10 days.

By contrast, Silver continues to run into a brick wall at 19 while momentum continues to wane. It took just one day this week for it to fall from 19 to 18. It also failed to break the downtrend in its weekly RSI again. Seen a different way, when it does finally break through, it’ll likely explode higher. The improvement in the MACD Line is encouraging but I would prefer to it fall back to its signal before taking off, i.e. the MACD Histogram to drop to zero and then rebound higher.

POSITIONING

Saving the best until last, it’s July 4^th this weekend. The Banks remain significantly short Gold. They would love nothing more than to squeeze the weak longs out, force them to cover their position by selling, and create a sharp move lower in price. This would enable the Banks to cover their short positions by buying the dip. The easiest way to push a boulder down a hill is when there is little resistance, like pushing it down a slide. In market terms, this means when liquidity is thin and trading volumes are low. There are few periods during the year when traders take off and liquidity is light, Christmas is one of them, July 4^th is another.

Many traders have already left the building and there are likely to be even fewer Friday. I’m not saying that it will happen but given the prevailing conditions in sentiment, technicals, and positioning, it is very much a risk. Once the momentum starts to the downside, it can take some time to stop. If it does occur, don’t expect it to be a one-day event.

CONCLUSION

While the trend higher could continue, anything is possible, the data suggests the odds are not in its favor. Again, I am not suggesting that anyone short this market because I believe any major drop will be the last great buying opportunity for what follows. We should welcome such a gift. That said, it could be a good time to lighten up any trading positions, take some profits ahead of that.

The support levels to watch on the downside in Gold are 1750 and 1670. A drop through the latter, although unlikely, would open up a move down to the 1400s before we rally next. In Silver, it’s easy, they’re 18, 17, and especially 16.