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Gold bounces off critical support heading into Fed week

Commentaries & Views

The gold price has been trading sideways since mid-2020, frustrating both bulls and bears while building cause for the next breakout in either direction. After gold's sharp doubling in price from 2016 to 2020, the safe-haven metal has been in a prolonged pullback/consolidation phase to digest those out-sized gains.

Gold's peak to trough correction ($2,089-$1,673) has been 20%, a textbook retracement down to its .382 Fibonacci retracement level. The high was re-tested in March of this year, while the lows had been tested three separate times over the past two years heading into this week.

With bear growls growing louder into the highly anticipated European Central Bank (ECB) interest rate decision on Thursday, there was a fourth test of the $1675 low. During the early hours of Thursday's Comex trading session, the gold price came precariously close to the $1675 Maginot Line of Gold Bulls' defense as traders awaited the ECB decision.

Yet the bears were denied once again as the news of a surprise 50 bps rate-hike from the ECB created a short-covering rally in deeply oversold bullion. Seeking to tame surging inflation after keeping rates negative since 2014, the ECB had for weeks flagged a 25 basis-point hike, until earlier this week, when sources told Reuters the central bank was weighing a bigger move.

This bigger move was indeed officially announced on Thursday when the central bank hiked by 50bps. The ECB also launched a bond protection plan, called the Transmission Protection Instrument (TPI), that is designed to cap the borrowing costs across the region in an effort to help heavily indebted countries like Italy, whose coalition government fell after the recent resignation of Prime Minister Mario Draghi.

With just under a week before the Federal Reserve's decision on July's rate hike, benchmark gold futures for August delivery on the Comex reversed $35 from $1678 into Thursday's close to remain well above the psychologically important $1700 level on the news.

Even though the extreme overbought U.S. dollar had anticipated an overly hawkish move by the ECB by moving sharply lower earlier this week, the gold price waited until the official announcement to move higher.

The parabolic rise in the world's reserve currency has been the main driver taking the gold price down 19% since peaking at $2078 in early March. And with the ECB now clearly joining the Federal Reserve in a global fight against inflation, this will help ease the soaring dollar which recently reached parity with the Euro.

After last week's U.S. inflation data surprised once again to the upside to pressure the gold price down to the critical support zone of $1675-$1700, gold futures speculators turned bearish for the first time in several years. The CFTC disaggregated Commitments of Traders (CoT) report for the week ending July 12th showed gold's speculative positioning had turned net short for the first time since May 2019, when gold was in the $1300s.

The CoT positioning data for gold also shows the Bullion Banks slashing their short positions to levels not seen since June 2019. While the commercial banks can continue to cut their shorts, pushing the price lower, their current positioning is bullish. It is also important to note that once the small specs became net short in May 2019, the GDXJ moved up over 55% in just a few months from similar deeply oversold conditions that we are currently experiencing.

Furthermore, when comparing the now 14-week sharp move down in gold stocks with the previous high-velocity decline in the sector in 2020, the capitulation phase of this 2-year correction is close to reaching its conclusion.

The higher-risk GDXJ is experiencing a high-velocity leg down that is coming close to the March 2020 pandemic decline, which saw the junior miner ETF move 51% lower in just 4-weeks. From its false-breakout peak in mid-April, GDXJ declined 44% into its 13th week ending last Friday, while reaching a deeper weekly oversold Relative Strength Index (RSI) level below 30.

When GDXJ sold down briefly just below the $29 level last Thursday, the junior miner ETF entered its most oversold condition in seven years. This high-risk junior gold stock fund has also held its long-term weekly support level at $30, showing relative strength to both gold and the GDX heading into Fed Week.

More importantly, the Gold Miners Bullish Percent Index ($BPGDM) has moved below 11, which is the lowest reading since the March 2020 spike low below 8. If this closely watched index goes down even further from here, it will likely sling-shot in the same way it did in early 2016 and March of 2020 climbing 202% and 189% in just a few months.

For the Fed, which meets next Tuesday and Wednesday, the market has already priced in a 77% chance of a 75 bps rate hike, as opposed to a 23% chance of a more aggressive 100 bps hike. In an effort to tame soaring inflation, the world's most powerful central bank is also expected to continue hiking rates by at least 50 bps at each meeting in the remainder of the year. This would raise the target range for the federal funds rate to 3.75-4.00% by 2023 which is more than indicated by the FOMC's dot plot (3.4%) and futures markets (3.55%).

Yet, the higher-than-expected CPI (9.1%) and PPI (11.3%) that came in last week are lagging indicators and reflect what prices did in June. Energy prices have pulled back sharply over the last month, along with other commodity markets. The Fed is well-aware of falling energy prices that might help weaken inflation figures, and the recent selling in other commodity markets is likely doing the same.

Another thing to note is that long-term rate expectations didn't budge after the huge inflation numbers were being priced in by the market. While short-dated T-bill yields soared, longer-term yields actually fell, resulting in the biggest inversion between two years and ten years since the dot-com bubble burst in 2000. This is added confirmation of an impending recession. Historically, bullion outperforms by a whopping 50% on average in a two-year period that covers 12 months before, and after a recession.

Meanwhile, the newest indication this week of the U.S. economy slowing under the weight of rising interest rates and high inflation is the number of Americans filing new claims for unemployment benefits rose for a third straight week last week to the highest in eight months. And factory activity slumped this month as well.

These are signs that next week the Fed is already thinking about where it will stop the current rate hike cycle, which could loosen the bears' grip on gold and stop the flow from it into bonds. And even a slightly less hawkish Chairman Powell during the subsequent press conference next Wednesday afternoon could create a short-covering explosion in the deeply oversold gold complex.

However, a break beneath critical double-bottom support in gold at $1675 remains roughly 2% away. If the Fed maintains its uber-hawkish stance in its dot-plot projections, this may provide enough fuel for the bears to "run the stops" below $1675 and send the gold price down to test is rising 200-week moving average at $1657.

Throughout the history of the secular gold bull market that began at the turn of the century, the gold price has a propensity for false moves lower, shaking off as many riders as possible before a strong up-leg can commence in earnest. A painful head-fake lower to get as many precious metal's longs out of position has preceded sharp up-legs in the gold complex in 2008 & 2020, before the next move to new highs quickly began from "V" bottoms.

Therefore, either the already deeply oversold junior mining complex is in the process of carving out a bottom here, or we have just a bit more downside to the $26-$27 support level in GDXJ which could result in a sling-shot reversal to the upside.

With the gold price teetering on the precipice of either a final flush down to the $1650 region, or having already bottomed as the market sniffs out a near-term Fed policy pivot, this is a great time to accumulate a basket of quality juniors to buy and hold before the next up-leg in this secular gold bull market begins. If you require assistance in doing so, and would like to receive my research, newsletter, portfolio, watch list, and trade alerts, please click here for instant access.

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