Gold Takes a Healthy Breather - David Brady (22/02/2019)

February 22, 2019

In last week’s article, “Gold - A Test of the 2016 High Next” , I stated the following:

With respect to the positioning of Funds, which have seen a massive swing from short to long since the lows of 1167…

And my conclusion…

Well, we have fallen short of 1377 so far and we’ve had a pullback to short-term support at 1325-1330, which was former resistance at 1331. The DSI peaked at 90 on Wednesday, when Gold peaked at 1350. It has fallen fifteen points in the past two days to 75.

Now we’re in no-man’s-land, as it were.

Gold could bounce straight back up to a negatively divergent higher high from both an RSI and DSI perspective, given the sharp move lower in both, to the 1360s or 1370s and then head down.

But the negative divergences on both the MACD Histogram and MACD Line are cause for concern in the short-term, especially as the MACD Line remains elevated.

Should we break 1325, then there is the prior low at 1305. Below there and we risk a move down to 1275-80, but let’s see if 1300-1305 holds first.

Personally, I would like to see a healthy pullback to 1280 or further, or at least go sideways for a while, to reset the MACD Line lower (and sentiment with it) to provide Gold with the energy it needs to take out key resistance at 1377. We have come a long way from 1167 and hit extreme overbought and overbullish levels. Sustainable breakouts do happen from such conditions, but it’s far easier from a more neutral position.

Funds have gone from short to long at an extremely fast pace, and as I said last week, a short-term reset would be ideal to provide the ammunition to move up to new highs.

INTER-MARKET ANALYSIS

Gold and the 10-Year Bond Yield have been extremely correlated on an inverse basis recently, and that was no different yesterday. Should yields continue to rise in the short term, Gold is likely heading lower.

The DXY is also heading higher, in my opinion. I’m still looking for a peak between 99-101.60. Should DXY continue to rally, that is likely to weigh on the yellow metal too.

Now, at the risk of boring everyone to death with this and attempting to raise the dead, some would say the most important correlation for Gold in dollar terms (XAU/USD) is to the USD/CNH, and more importantly recently, Gold in yuan terms, or XAU/CNY. Many still doubt its relevance. Look at the correlation between XAU/USD and XAU/CNY since they both bottomed on August 16 ^th:

And then there is simple math:

XAU/USD = XAU/CNY divided by USD/CNH

The reason why Gold in dollar terms and in yuan terms have been so correlated since that day in August is that the USD/CNH has been relatively stable. Fix one variable in the equation above and the other two are directly correlated.

The worst-case scenario for Gold in dollar terms is that XAU/CNY falls and the USD/CNH rises. Unfortunately, there is a risk of that in the short-term.

XAU/CNY hit a negatively divergent and extreme overbought peak on Wednesday at 9089 and has fallen back since. Like Gold in dollar terms, it could go either way from here, but 8700 is a key level that needs to hold in order to for Gold to maintain its uptrend.

At the same time, USD/CNH has been hitting lower lows recently, but they have been positively divergent at extreme oversold levels. Should the USD/CNH rally from here at the same time XAU/CNY falls, you do the math. It’s simple: Gold falls in dollar terms.

As redundant as this whole thesis may seem to some, please keep an eye on this. Ignoring it could be a painful mistake.

CONCLUSION

Although it is difficult to determine the next short-term moves in Gold, the bigger picture has not changed in the past 24 hours. Central banks are buying Gold at the highest rate since the 1970s. The Fed’s actual reversal to rate cuts and QE is inevitable, in my opinion, and even Yellen confirmed this week that this likely means a far weaker dollar, just as in 2009. This would also mean a far weaker USD/CNH. This has been and remains my primary scenario for a sustainable rally to new highs in Gold. The point is that Gold is still likely going a lot higher, and this is the pullback many of us were waiting for to BTFD.

Now is the time to be patient once more. To wait for Gold to find support on the downside, and get ready for the next leg up to new highs. Until then, the range is 1305-1350.

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