June 11, 2020
The latest economic information is driven by the following:
- The surprising increase in non-farm payrolls, which drove stocks and bond yields higher. I believe this is at best temporary given the ongoing destruction of the mainstream economy. The euphoria that followed will likely be short-lived.
- We have both deflation and inflation. Deflation in discretionary products and services and inflation in everything people need, i.e., necessities such as food and energy costs. This means that for the vast majority of people, inflation is going up, not down, signaling stagflation has already begun. In my opinion, it is likely to get worse as supply shocks become more pervasive. For now though, everyone is focused on deflation.
- Government continues to throw money at the problem with new stimulus measures, and the Fed finances the massive and growing deficits and treasury issuance by printing money out of thin air. However, the Fed said in the FOMC meeting this week that QE would be fixed at $80 billion monthly going forward, or ~$1 trillion annually. Given that the deficit has been rising ~$1 trillion a month, the currency being printed won’t come even close to funding the new debt and everything else that the Fed is buying these days. This confirms the data we have been seeing for weeks now that the Fed is tapering its liquidity injections. This means the risk of lower stock prices and higher bond yields just rose dramatically. However, this is likely to be short-term as Powell turns the monetary spigots back on as soon as stocks dump. From a gold and silver perspective, the combination of higher bond yields and lower inflation expectations could put pressure on both to the downside until the Fed presses the gas pedal on the currency printer again.
The daily technicals for Gold don’t tell us much. We’re still stuck in the wedge that has been in place since April. The overbought condition has been corrected, but extreme bullishness remains. Given the preceding rally, one would expect Gold to break up, and it may. But given the fundamental backdrop, the risk has increased to the downside, imho. The levels to watch in the short-term are resistance at 1760 and support at 1670.
The weekly chart just confirms what we’re seeing in the daily, but it, too, shows that while Gold has also corrected its extreme overbought condition from an RSI of 80 to 60 as of today, it could still go a lot lower yet.
The monthly chart is the primary concern. It shows the RSI at 77, its highest level since the peak in August 2011. While there were other higher peaks in March 2008 and in May 2006, they also led to drops of 35% and 25% respectively in the following months.
The March 2008 drop is especially pertinent, because that was a period when nominal and real yields both spiked higher as inflation expectations crashed along with stocks. Sound familiar? Back then, Gold fell from March to October 2008 as real yields spiked higher.
While this time may be different, it seldom is. The data is telling us to be cautious here. That said, keep in mind that if we do see renewed downside in precious metals and miners over the next few weeks and months, once the Fed is forced to step back in again by pressing down hard on the gas pedal of money printing, it’s game over: Gold, Silver, and the miners explode higher.
This is where it gets truly interesting. In the article below from January 23rd, I asked the following question:
In that article, I cited the abnormal conditions to look for that would signal the futures market has broken down and prices are about to explode higher:
Simply put: if the price is rising and Funds are cutting their longs and Commercials are cutting their short positions. Usually it’s the opposite, and this suggests that the futures market is broken. This is what we’re seeing in Gold Funds’ and Commercials’ positioning today:
We’re seeing the same conditions that we saw in Palladium back in 2019, which signaled the futures market was broken and was followed by an explosion in price. This is also reinforced by the blow-out in physical premiums we have seen in Gold and Silver in March.
That said, there are three key caveats in the short-term.
- Palladium suffered a significant pullback from March to May 2019 before it took off. Gold and Silver could do the same.
- The Banks are not adding to their short position, but they’re not cutting it either. They remain significantly short Gold. The Producers are slashing their short position, which is why the overall Commercials’ net short position is dropping.
- Palladium suffered a near 50% drop in one month from February to March this year as stocks dumped. Gold and Silver dumped in 2008 as stocks crashed. There is the risk of a significant drop if stocks suffer a significant drop imminently.
In summary, the risk of a sharp reversal in precious metals and miners is rising as the Fed tapers its liquidity injections. However, if 2008 is playing out again, then Gold, Silver, and the miners will take off once the Fed is forced to turn the hose of liquidity back on full blast. This will occur when stocks fall hard and/or bond yields spike higher. Following that, there is no looking back for precious metals and miners, imho.