Price Analysis: Gold Diverges from Bonds as Critical Test Looms at $1800
The analysis last month showed that selling exhaustion may be near in the gold market. Since then, gold continues to be range-bound between $1750 and $1800 running up against both solid resistance and support. Meanwhile, silver has shown a mini-breakout.
The $1800 level for gold is in play this week and could open the door for a big move if it gets through it soon.
More importantly, gold and bonds have shown a strong divergence in October which is a very bullish sign.
Finally, the gold miners have made a strong move up but hit against solid resistance this week ($33 on the GDX). Is the recent action in the GDX a short-covering rally or the start of the next big move up? Obviously, no one knows for sure, but more indicators are starting to turn bullish.
Resistance and Support
After the “hawkish” Fed meeting in June, gold saw a major correction causing it to fall from $1900 to under $1800 in a matter of days. Since then, gold has been stuck around the $1800 level. Any move too high ($1810-$1835) gets sold quickly and any deeper pullbacks ($1750-$1770) get bought.
The latest week saw another failed retest of the $1800 level. After spending most of the week slowly moving higher, the price finally burst through $1800 Friday morning and even hit $1813. Unfortunately, when Powell said the Fed was still on track to taper, gold fell back through $1800, finishing the week around $1792.
What appeared to be a bullish move (breaking through $1800) quickly turned bearish. Another failed attempt to break through $1800 means the bulls need to find momentum quickly or risk seeing $1760 again (or lower). If gold can reclaim $1800 early this week, it will create bullish momentum. The more time it spends below $1800, the more likely it retests support.
Outlook: Bearish unless gold reclaims $1800 very soon
Silver followed a slightly different path since June. While gold found solid support, silver continued to make lower lows. It went from $28 down to $21.48. As the chart below shows, the moves were highly correlated with moves in gold but were not as range-bound.
Silver has also seen a much stronger bounce off the lows, up above $24 and closing at $24.45 on Friday. This represents an almost 14% move up off the lows. For silver, holding the $24 level has become critical to maintaining bullish momentum.
Outlook: Slightly bullish, but needs above $25 to confirm
Figure: 1 Gold and Silver Price Action
Daily Moving Averages (DMA)
The 50 DMA is still sitting below the 200 DMA, but moving upwards. Due to the range-bound nature of gold since June, the 50 and 200 DMA have not been stuck this closely together for at least 10 years.
As the chart below shows, the 50 DMA tends to overshoot and undershoot the 200 DMA. The market is clearly looking for a catalyst to move out of this tight consolidation range. When it breaks through, it could make a very big move in a short amount of time.
Even though 50 is still below 200, the activity is starting to look bullish. The market has already priced in all the bad news: QE to end by mid-2022, possible interest rate increases in 2022, etc. Unless the Fed came out with more aggressive monetary policy (unlikely), the news is likely to favor gold (as stagflation becomes more evident).
If the market has fully digested Powell’s taper comments (TBD this week), this is starting to look like a bullish setup. The market looks like a coiled spring ready to pop!
Outlook: Surprisingly bullish
Figure: 2 Gold 50/200 DMA
Silver has more work to do in order to get the 50 DMA above the 200 DMA. This chart still looks bearish, but the bulls do have a few things going for them.
First, the 50 DMA has finally started to turn upwards (hard to see on the chart, but it has).
Secondly, looking over 10 years, the magnitude of the 50 DMA move below 200 DMA looks like an oversold situation. Unlike gold, the two averages have not been close together. Such a big move is usually followed by a reversal.
Finally, the current activity almost looks like a reverse of the 2013 big move down. In 2013, after a big move down, there was consolidation followed by continued downward momentum.
Even with these three potential bullish stories, the overall chart still looks bearish until silver’s 50 DMA can really start to push through the 200 DMA.
Figure: 3 Silver 50/200 DMA
Comex Open Interest
The two charts below show the open interest compared to the price in both gold and silver. The overlap is not perfect, but major moves in one generally occur in tandem with the other as speculators push and pull the price around with paper contracts.
Open interest has moved back above 500k. If this holds, which it failed to do so in early October, then this looks bullish.
Outlook: Cautiously Bullish
Figure: 4 Gold Price vs Open Interest
Open interest is still sitting at multi-year lows below 150k. Open interest has not responded to confirm the big price move up. If open interest does not start moving up soon to confirm the price move, then this looks bearish.
Outlook: Wait and see
Figure: 5 Silver Price vs Open Interest
To evaluate the true relationship of open interest and price action, the table below calculates the correlation between the two. The methodology takes the percentage change over a specific period and then calculates a correlation across multiple periods between the two variables.
Figure: 6 Price/OI Correlation
As shown, the correlation is not always high but at times it can be very high. Gold is showing a very strong correlation over the past 21 days and even higher over the last 12 months. If gold is going to push through $1800 convincingly, it will be driven by open interest.
Silver is less certain. The table confirms what was shown in the chart, price and open interest are not highly correlated at the moment.
The gold mining companies often magnify the moves in gold because they are leveraged to the price. Small price changes can have major impacts on profitability. Many times, the movement in stock precedes a move in the metal itself. Stocks are forward-looking and the sell-off or price spike in the miners indicates the market anticipating the future movement in gold. Below are two charts showing the historical and more recent trends.
Historically, the HUI is extremely undervalued. The HUI would have to increase 4x to reach the highs seen in the 1990s and 2000s. The sector has never really recovered from the gold price sell-off in 2008.
Figure: 7 HUI to Gold Historical Trend
Looking at the more recent trend shows how the miners typically lead the price movement in gold (e.g. Mar 2020, July 2020, Mar 2021, May 2021, Aug 2021). There are exceptions such as April 2020, but lately, the gold stocks are front running the price moves in gold.
The ratio looks to have bottomed on Oct 1. It has moved up in a big way throughout the month of October. The ratio has been in a steady decline since May 17 but appears to have reversed. Considering that miners typically lead the price, this is a bullish sign. It supports the argument that bottoms have been made in this move.
Figure: 8 HUI to Gold Current Trend
Love or hate the traders/speculators in the paper futures market, but it’s impossible to ignore the impact they have on price. The charts below show that the more active they are, the more prices tend to move up.
At first, it was thought that volume may start to increase after Labor Day marked the end of summer. Unfortunately, volume has continued to stay low. It’s hard to imagine volume can go lower, but there does not seem any major catalyst to bring back trade volume.
Gold and Silver Outlook: Neutral
Figure: 9 Gold Volume and Open Interest
Figure: 10 Silver Volume and Open Interest
USD and Treasuries
Price action can be driven by activity in the Treasury market or US Dollar exchange rate. A big move up in gold will often occur simultaneously with a move down in US debt rates (a move up in Treasury prices) or a move down in the dollar. This relationship can also be seen over longer time periods as the chart below demonstrates. While gold magnifies the move, the pops and dips tend to move in the same direction.
Perhaps the most important conclusion from the chart below is that the gold and bond market have started to diverge. Since October 1, gold has moved up but the bond market has seen rates rise instead of fall. This is a critical development that will be important to watch. If this trend holds, gold could be about to hit a massive new leg up.
Please note: IEF is the 7-10 year iShares ETF (a move up represents falling rates) and the Dollar return is inverted in this chart to show a positive correlation. They are also plotted on the right y-axis to better show the price movement.
Figure: 11 Price Compare DXY, GLD, 10-year
The dollar (blue line reversed) had hit resistance at 93.50 having a triple top over 6 months. It broke through that level in October and gold still continued to climb. This is another bullish sign. In the past few trading sessions, the dollar was under pressure once again. If the dollar turns back down it will only further support a bullish move up in gold.
Outlook: Very bullish
Gold Silver Ratio
Gold and silver are very highly correlated but do not move in perfect lockstep. The Gold/Silver Ratio is used by traders to determine the relative value between the two metals. Historically, the ratio averages between 40 and 60, so outside this ban can indicate a coming reversion to the mean.
While silver had made up ground since last March, a major reversal occurred on July 2 bringing the ratio from 67 up to 79.5. Sudden moves like this typically reverse quickly. Silver saw the beginning of this reversal in October, but it still has a long way to go.
Outlook: Silver Bullish relative to gold
Figure: 12 Gold Silver Ratio
Bringing it all together
The table below shows a snapshot of the trends that exist in the plots above. It compares current values to one month, one year, and three years ago. It also looks at the 50 and 200 daily moving averages. While DMAs are typically only calculated for prices, the DMA on the other variables can show where the current values stack compared to the recent history. For example, open interest in silver is sitting below the 50 and 200 DMAs. Is it possible this indicates an oversold situation?
- Gold and silver have seen a solid October so far in terms of price up 2.7% and 7.8%
- The HUI Gold ratio increased by 7%
- Friday saw large volume in both metals
Figure: 13 Summary Table
Obviously, no one can predict where the price of gold and silver are going in the future. Many articles in the Exploring Finance series look at the fundamental cases that theoretically should drive prices higher in the medium to long term. This analysis looked at some of the short-term drivers and showed how open interest is a major factor in the price of gold and silver regardless of what may be occurring elsewhere.
The two biggest takeaways from this analysis are:
- $1800 has proved very strong resistance. Gold needs to break through to set up a strong end-of-year rally. Another failure will keep gold trapped between $1750 and $1800 or even lower.
- Gold and bonds/dollar diverged in October. This is a major development that must be watched closely going forward. If the divergence continues, it will be very bullish for gold and silver.
Data Updated: Nightly around 11 PM Eastern
Last Updated: Oct 22, 2021