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Gold remains in a bullish flag heading into fed week

Commentaries & Views

Pressure is building up in the gold price, which has been contained in a bullish 8-week symmetrical triangle consolidation pattern heading into Fed week. While the overall trend has been lower, price has largely chopped sideways after the metal became extreme overbought in August. Demand for bullion has softened amid optimism over a U.S./China trade deal, but it is also being supported by rising expectations of another Federal Reserve rate cut at the end of October.

Although December Gold had been trading in a narrow range for the past few weeks on decreasing volume, the safe-haven metal popped back above the $1500 psychological level yesterday to finish at its highest price in just over two weeks. European Central Bank President Mario Draghi left the central bank on Thursday with the promise of seemingly endless negative rates, along with €20bn per month of new quantitative easing. The continued global central bank “race to debase” makes gold a stand-out choice for long-term wealth protection.

Gold prices have continued to consolidate in a tight range despite the U.S./China trade war appearing to be coming to an end with an announcement on October 11th that both sides are in the process of reaching a deal. The prospect of a trade deal reduces the risk of a global economic recession and therefore cuts the demand for safe-haven assets such as gold.

U.S. President Donald Trump has stated his feeling that a deal would be signed ahead of the November 16-17 Asia-Pacific Economic Cooperation (APEC) meetings in Chile. On Monday, President Trump’s tone remained optimistic while speaking to reporters before a Cabinet meeting, when he said: “The deal with China’s coming along very well. They want to make a deal.”

However, it remains to be seen if the trade truce will lead to an agreement as China vows to retaliate to the U.S. blacklist, with Foreign Ministry Spokesperson Hua Chunying pledging to “make an official announcement” as to whether President Xi Jinping will attend the APEC meeting in Chile.

Moreover, unionized workers at Chile’s Codelco, the world’s largest copper miner, joined thousands on Wednesday to engage in strike actions nation-wide. The strike has quickly degenerated into widespread violence, leaving at least 15 dead, over 1,600 in detention, and seen six major cities under a state of emergency as of yesterday. How this recent civil unrest will affect the upcoming conference in Santiago, Chile, along with the pending U.S./Chinese trade dealings, remains to be seen.

The recent Brexit uncertainty has also assisted in keeping a higher demand for gold this week, with the British Parliament making it difficult for UK Prime Minister Boris Johnson to fulfill his promise of delivering Brexit on October 31st. More than three years after Britons voted 52%-48% to be the first sovereign country to leave the European project, the future of Brexit remains unclear.

After the rejection of Johnson’s timetable for Brexit legislation by the UK Parliament on Tuesday, the Prime Minister called for a general election on December 12th to break Britain’s Brexit impasse, conceding for the first time he will not meet his “do or die” deadline to leave the European Union next week. Johnson seems to still hold out hope of securing a deal with Brussels, offering parliament until Nov. 6 to ratify an agreement he settled with the EU last week.

With the next FOMC meeting speech on tap for next Wednesday at 2:00pm EST, the CME FedWatch Tool has shown growing speculation for another 25bp reduction on October 30th, as the gauge is now reflecting a greater than 93% probability for the benchmark interest rate to narrow to 1.50% - 1.75%.

Although the cut is largely priced in, the growing dissent within the Fed since the last meeting in September may fuel fears of a policy error, as the world’s largest central bank makes an unexpected announcement to purchase U.S. Treasury Bills in the secondary market. Even though U.S. equities are trading near all-time highs, recent negative data prints have been coming out of the U.S. economy. Chairman Jerome Powell may push to further embark on the rate easing cycle amid signs of slowing consumption.

The central bank could decide to continue insulating the U.S. economy, while private-sector spending “has been the key driver of growth.” The Fed may have little choice but to reverse the four rate hikes from December 2018, as “weakness in global growth and trade policy uncertainty have weighed on the economy and pose ongoing risks.”

With this in mind, falling interest rates, along with fears of a global recession, may heighten the appeal of gold once the Fed has spoken next week. If so, market participants would return to the safe-haven metal as a hedge against fiat currencies, while the International Monetary Fund (IMF) continues to cut its global growth forecast.

Furthermore, as mentioned in this column last week, the silver price has continued to lead gold with the gold/silver ratio beginning to roll over recently. The downtrend line from the metal’s peak at $19.75 eight weeks ago was broken on the upside yesterday and when we begin to see this tiny sector lead the precious metals complex in earnest, a breakout to the upside in gold could be close behind.

The odds of a bullish breakout resulting from this symmetrical triangle in the gold price would increase if December Gold can manage to close above $1525, while a bearish result towards the $1450 region would begin to take shape if the $1478 level is broken on a closing basis. The GDX/GLD ratio is attempting to bottom at its rising 200-day moving average and will require a strong bounce higher to bring more buying into the gold complex as well. I see this sideways price action as very bullish for the sector and in bull markets, surprises tend to be to the upside.

The GDX has successfully tested and bounced from the strong support region at $26 for the third time with decreasing volume recently, while moving higher towards its 50-day moving average. Although the global miner ETF has been leading the precious metals correction lower, an overly dovish Fed would bring in high-volume, algorithm-based buying into the entire complex. Once we see a close above $28.50 in the GDX, I expect to see important resistance at the $31 level tested quickly.

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