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Gold price action hints of a brewing stock market crash

Commentaries & Views

Gold has had a tumultuous year to say the least. The safe-haven metal soared above long-term resistance at $2000 per ounce briefly in March after Russia began its military occupation in Ukraine, then sank below long-term support at $1700 this week as the Fed toughened its approach to repressing the highest inflation experienced in over 40 years.

Within the same timeframe, after repeatedly insisting rapidly rising inflation was transitory since late 2021, Fed Chair Jerome Powell and colleagues moved from an ultra-dovish zero-interest rate policy to expectations of a Fed Funds rate over 4.5% by year-end. This abrupt and about-face shift in monetary policy has the U.S. dollar trading at 20-year highs in parabolic fashion, keeping gold priced in the world's reserve currency under severe pressure.

Extreme volatility came into the marketplace mid-week after Russian President Vladimir Putin ordered a partial mobilization of reservists to bolster his forces in Ukraine, followed by the Federal Open Market Committee (FOMC) voting to raise interest rates by 75 basis points. The Fed has also set a higher-than-expected terminal rate of 4.6% in 2023, even if inflation is not at its 2% target.

During the post-FOMC meeting press conference, Fed Chairman Jerome Powell warned consumers economic pain is on the horizon as the central bank focuses on bringing inflation down. "Reducing inflation will likely require a sustained time of below trend growth," said Powell on Wednesday.

If the Fed's forecast is accurate, 4.6% means another 1.3 million people unemployed. Asked by a reporter if this was acceptable, Powell said, "We have got to get inflation behind us. I wish there were a painless way to do that. There isn't."

The rapid rise in rates has caused 62% of possible U.S. Treasury Yield Curves between 3-months and 30-years to invert. Any reading over 55% has historically led to a recession, and Powell hinted as much during the press conference on Wednesday. The central bank said they see U.S. GDP growing by only 0.2% in 2022, and rising by a mere 1.8% in the longer-term. "No one knows whether this process will lead to a recession or, if so, how significant that recession will be," the Fed Chairman said.

Not only did the U.S. central bank raise rates by three-quarters of a percentage point for a third consecutive time on Wednesday, the British, Swiss, and Norwegian central banks all delivered large hikes on Thursday as well. In fact, central banks in the 10 big developed economies have raised rates by a combined 1,965 basis points in this cycle to date, with Japan the holdout "dove", sticking on Thursday with its decades-long, ultra-low rates policy that has destroyed its bond market.

Yet, the persistence of inflation continuing to support an aggressive effort by several major central banks this week, in contrast with the lack of peacemakers in positions of power around the world, has kept December Gold futures trading above critical support at $1675.

With the gold price deeply oversold, the plethora of stops below this closely watched level had been absorbed by safe-haven buying as the stock market begins to price in recession. Gold made new weekly lows, then weekly highs, after the Powell press conference in just 45 minutes, creating even more uncertainty around this critical support zone.

The bullish case sees crisis-hedge gold buying creating a bottom in the Gold/S&P Ratio when the stock market peaked at an all-time high to begin 2022. The weekly chart also shows this ratio in the process of forming the right shoulder of an inverse head & shoulders bottoming pattern.

However, time may be running out technically for gold bulls if December futures are unable to close above $1705 on a quarterly basis next Friday. Failure to do so would bring the $1550 region into play, which is the 50% Fibonacci retracement after the gold price doubled from $1045 in late 2015, to $2090 by mid-2020.

While the Fed is determined to destroy demand and cause more "pain" to a marketplace saddled with increasingly higher debt payments after each outsized rate-hike, the S&P 500 has nearly sold down to its June low in technical textbook fashion as I type this missive.

After back-testing it's falling 200-day moving average in mid-August, which coincided with a downtrend line from the January peak, the world's most closely followed index has turned lower and is moving sharply towards the June low at 3636.

With the rise in interest rates having been so rapid that the marketplace is likely only beginning to see the economic consequence of the initial rate hikes, a margin-call induced selloff could begin if the S&P 500 moves below this level. 

On a potential panic move below its rising 200-week moving average at 3600, I would expect the Fed to consider pivoting faster than the current marketplace expectations. During an election year when the markets are dropping, while the global economy is barreling towards recession, look for Fed-speak to begin turning dovish if the S&P 500 craters towards critical support at 3200 during "crash season."

In the meantime, the U.S. dollar continues to be the safe-haven of choice, while the gold complex may experience further pain if the marketplace creates a wave of margin call selling into crash season. But the good news is that opposed to the mining complex being extreme overbought ahead of the 2008 financial crisis and the 2020 pandemic market crash, gold stocks have already been sold down to deeply depressed and opportunistic levels as the stock market appears to be in the process of another leg down.

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