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Gold's tedious coiling action tightens as inflation surges

Commentaries & Views

The key $1,800 area continues to be a magnet for gold. Rallies have been sold, and sell-offs have been bought with traders on both sides continuing to be whipsawed out of position. Since mid-2021, any advance, or decline, that bullion has made quickly ran out of steam and has returned to the $1,800 zone.

This frustrating sideways movement inside of a tight $100 range has resulted in what technician's call "coiling action", which will likely end in a sharp move in either direction. The tighter and lengthier the trading action becomes around $1,800, the more pronounced the eventual move will be, whether up or down.

Gold Futures closed the month of January just below $1800 per ounce, remaining inside an 18-month bullish symetrical triangle that is awaiting a strong catalyst to break in either direction soon. On the upside, a monthly close above $1900 would support the next leg higher in gold. On the downside, a monthly close below $1750 would set up a possible move towards strong support being tested at $1675.

The longer the consolidation, the bigger the move will be once the breakout occurs. With the long-term bullish uptrend line providing consistent support, the likelihood of a bullish breakout is higher than a bearish breakdown. Looking at the bigger picture, gold has created a significant 12-year cup and handle pattern, which would be completed once the $2100 level has been breached on a monthly closing basis.

There are not too many examples of a multi-year cup and handle pattern in the major markets, and investors should understand how bullish this pattern can be when it occurs over a long period of time. The current cup and handle pattern in gold projects to a technically measured upside target of around $3,000.

Recently, this expected upcoming strong move has been leaning towards the upside. Gold prices have recovered quickly from the support low of $1780 touched in late January on hawkish Fed-speak. Bloomberg Markets Live Blog reported convincing evidence of a large entity snapping up gold bullion below $1800 last week. There were two sharp intra-day "V" shaped recoveries once the $1800 level was breached and gold headed towards key support at $1780 during the next two sessions after the story was posted on February 2nd.

With Chinese markets closed most of last week during the Chinese New Year holiday celebrations, the safe-haven metal attempted to sell down below the key $1800 line of support. Yet, strong western buying came in quickly each time, ending with an intra-day "V" shaped recovery back above this important level. On February 3rd, the gold price broke down towards $1780, yet quicky reversed from the $1790 level to close above $1800.

After the U.S. jobs report came in much better-than-expected the following session on February 4th, the gold price took a quick dive towards $1780 once more. Yet, bullion quickly recovered into the U.S. market open to remain above $1800 on a weekly closing basis, despite a new 52-week high being made in the U.S. 10-year Treasury yield.

The 2-year Treasury yield, the rate most closely associated with the near-term path of Federal Reserve policy, had its biggest one-day gain in more than a decade this Thursday following the hotter than expected Consumer Price Index (CPI) showed inflation in the U.S. soared in January to 7.5%. The data marked the fastest pace of price gains since February 1982 when the index reached 7.6%. Core prices jumped 6% last month YoY, outpacing December's 5.5% reading when it reached the sharpest increase since August 1982.

Although both yields and the U.S. dollar surged Thursday as markets quickly began to re-price expectations of a potential 50 basis points rate hike at the Federal Reserve's mid-March meeting, the gold price reversed from $1820 support and has closed up during 8 of the past 9 Comex sessions. With all three U.S. equity big board indices sharply reversing from their respective downtrend lines after the inflation news, gold has remained a steady safe-haven asset to hold with formerly high-flying FANG stocks being sold down sharply, along with crypto currencies, over the past several weeks.

Comments this week from Fed policy makers suggest the probability of at least four quarter-percentage point rate hikes in 2022. And in light of strong employment and inflation data, markets are starting to price in a 50-basis-point rate hike to kick off the rate hike cycle in mid-March. That would bring the Fed Funds Rate up by a total of up to 1.25% for the year.

But with inflation currently running at 7.5%, a 1.25% hike is hardly going to make a dent, not to mention the interest payments alone on the now $30 trillion U.S debt would soon be closing in on $1 trillion. With the coming rate-hike cycle being mostly priced into gold, its price will be largely driven by runaway inflation and the risk that the Fed is on the verge of making a major policy error.

Furthermore, geopolitical risks have increased with a crisis unfolding between Russia and Ukraine that could yet result in armed conflict in Europe. This comes on top of ongoing tensions between the U.S. and China over Taiwan, as well as the threat of conflict in Korea. For many investors, gold maintains its appeal as a safe haven asset. If China moves into Taiwan and Russia moves into Ukraine on a coordinated basis sometime after the conclusion of the Winter Olympic Games in Beijing on February 20th, the gold price volatility would increase dramatically to say the least.

Meanwhile, precious metals stocks have recently been trending with equities despite both gold and silver remaining well bid. Yet, we have seen a bit of FANG stock rotation into the two largest global miner sector bellwethers since the Nasdaq peaked in late 2021. Both Newmont Gold Corp (NEM), and Barrick Gold (GOLD) have been bifurcating higher from the sector after making significant lows in December.

Historically, the start of Federal Reserve rate-hike cycles has marked significant bottoms in the gold price in 1999, 2004, and 2015. Similar to the current situation in the gold complex, during the lead-in to a telegraphed rate-hike cycle by the Fed in late 2015, mining stocks began to bottom six months prior to the announced hike in mid-December. And once the tightening process began, the mining sector nearly tripled in just six months from a similarly depressed level and accumulation time-frame which has recently been taking place.

If past is prologue, six months from the low struck in GDX at the $28 level on the last day of September would take us into the first week of March. Once we see a weekly close above $35 in the global miner ETF, the odds would increase significantly of the mining sector having formed a major accumulative bottom.

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