We are seeing a number of notable reversals in our checklists this month. Typically, these mark the beginning of major turning points in the trend. Whilst our process has been neutral on gold for some time, the checklist has this month turned negative– indicating that investors should be cautious, and traders could even look to sell the yellow metal short.
Liquidity. Whilst the current ‘excess’ liquidity is considered positive for gold, the rate of change has been negative for some time, largely offsetting this. It is interesting to see note that this has made multi-year lows in 2017, and should this break below zero it would then be considered a negative headwind for bullion.
Real interest rate. The US real interest rate has moved higher on the month, despite an uptick in CPI inflation, meaning that 10-year government bond yields have risen by a greater magnitude. Gold benefits from a negative or downward trending real interest rate. Whilst we may the recent downtrend resume, for now the trend is unclear, so we are focused on the directional change – which gets a negative score on our checklist.
ETF Flows. Following last month’s negative divergence, ETF inflows are converging with the selling we have seen in gold over the past couple of weeks. It suggests that investors have been buying the gold-backed ETF despite weakness. Normally this would be considered bullish for the spot market, however, I view this reversion as corrective in nature as opposed to a signal that gold may be about to resume its move higher on this factor alone. Therefore, we regard the flows as neutral this month, but are improving on last month’s negative divergence.
Futures positioning. Gold is a highly speculatively-driven market. Whilst we tend to look at futures positioning for most markets we trade, and pay particular attention to this when it comes to gold. As you can see, long positioning has surged and from a contrarian perspective this is a clear negative from our perspective.
Options positioning. In contrast to the net futures position, positioning in the option market is hardly extreme. In fact, it is now pretty much neutral having returned from last month’s excursion. This scores ‘0’ on our checklist.
Short interest. Short interest in gold mining stocks, as measured by the GDX ETF, remains extremely high following its upsurge in recent months. From a contrarian perspective, this is supportive of the spot metal as equity investors are mostly speculating on a decline in the underlying value of these companies (gold itself!). This receives a +1 on our checklist.
Seasonality. Finally, we arrive at seasonal performance. As you can see, seasonality is somewhat mixed in October, though the magnitude of declines observed in recent years on average outweigh the positive months. We consider this to be negative currently for gold.
Conclusion. In total we see a score of -1.5 for gold heading in to October. This shows a significant deterioration on September’s neutral reading, and suggests approaching gold with a negative bias over the coming month (i.e. longs should consider closing their positions, and shorts may look for potential selling opportunities).
The chart of gold (at the time of publication) makes this all the more interesting, as we may have seen a potential ‘false break’ of the downward sloping trend line that gold bugs have identified as the trigger for a breakout of the multi-year consolidation defined by this pattern. If it is a ‘false break’, technicians consider this to be bearish (not just neutral) and could end up surprising many people who believe that it is just a matter of time before gold completes its current consolidation and makes a sustained move higher (i.e. it could end up being a multi-year bearish consolidation before a break lower!).
Regardless of the chart or other opinions in the market, we stick to what we know works – our process. We trade what we see when we review this each month with our members at our Trading Club. That’s the difference between trading an opinion and trading on facts, and it allows us to be flexible in changing our view with information before us. This provides our edge, and this contrast is what makes a market. Still, nobody can predict the future, and we can only do our best to (on average) remain on the right side of the trade over the long run.
It’s a fascinating time to be an investor!
Have a great trading week,
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