Gold Launches Like a Ballistic Missile But Range is Unknown

  • 19 Sep 2017
  • By Henry Park
  • Topics: Metals

Along with national security experts, global market watchers cautiously observed as North Korea launched an intercontinental ballistic missile (ICBM) on Friday, a weapons test that was not only provocative militarily, but represents a major improvement in the reclusive communist regime’s demonstrated technological abilities.   As the missile flew over northern Japan, onlookers from the earth below were transfixed, and wondered aloud where the missile’s trajectory would take it based on the power and speed of its observed path.  Thankfully, the missile landed in the ocean 2,000 km from Tokyo.  But military experts agreed that the expanded range of North Korea’s missile capabilities casts fear over the entire region.

When fear sweeps over the global financial markets, investors typically move into what are called “safe haven” assets which are supposed to outperform more risky asset classes in times of heightened volatility.  Gold is a classic safe haven instrument and has been the beneficiary for years of a worldwide belief that equity and fixed income markets were due to crash, which would transfer tremendous wealth from those markets into precious metals. 

But after the surprise missile launch, markets seem to have shrugged off the initial worries over military conflict.  Stock markets recovered and ended the week reaching for all time highs. Gold futures contracts settled at $1,323.50 per ounce in brisk trading on Friday, which is 2.7% off its prior weekly close at $1,362.  So, on a day when geopolitical tensions should have sent safe haven assets into the stratosphere, gold actually declined, as did silver, platinum, and palladium. 

Perhaps precious metals may no longer be considered proxies for political risk, as they were in the past.  After all, we have seen terrorist bombings in Europe and war in oil producing countries, but the movements in gold and silver seem more tied to the financial wars being waged between central banks in the effort to devalue their own currencies.  Anecdotally, it is rare to find an investor these days who buys gold as a safe haven play.  More often a gold investor is chasing speculative gains on separate asset class, than trying to preserve the value of a diversified portfolio.  In fact, government bonds now seem the more traditional safe haven play, as negative interest rates in Europe force sovereign bond holders to pay interest, rather than receive it.   That is more typical of a safe haven play, where the cost of carry is negative.  Gold will in all likelihood regain its membership in the safe haven club, but for traders, it is important to note when the proper trading relationships and signals must be re-examined. 

Gold may have paused when the “gold is a safe haven” theorists thought that it should have climbed toward $1,400, but the bullish move which preceded it from created a powerful range expansion on the daily charts, not unlike a missile in flight.

Figure 1

And traders and central banks are now watching the arc of this flight path wondering when it might fall back to earth.

The rally from July has been impressive, taking gold from $1,210 in July and punched through the $1300 level where it had met heavy selling earlier in the summer.  A Bloomberg news article at the time, “Hedge Funds Are Losing Faith in Precious Metals” , noted that money managers had gotten so bearish on gold that their net short positions had climbed to levels not seen in years, as seen in the graph below from July. 

Figure 2

As typically happens in these situations, the fact that everyone was “under invested” meant that no one was left to sell.  If there is no one selling, then prices usually go up.  The almost uninterrupted rally since then completely reversed the trend of speculative positioning since the start of the year.  Large speculators are now holding over 200K contracts long.  

Figure 3

The initial reduction in hedge fund gold positions were most likely due to a change in investor expectations regarding the next action by the US Federal Reserve Bank.  Gold has historically had an inverse relationship with the US Dollar, and higher US interest rates signal a stronger dollar, which in turn signals weaker gold.  The US Central Bank is expected to raise interest rates later this year and that probability went up recently as the US White House and the Congressional opponents agreed to increase the US debt ceiling and finance the government until mid-December.  In addition, crude oil prices rebounded over the summer, and US core inflation was stronger than expected in August.  On top of that, the damage from Hurricane Irma in the US coastal state of Florida was less than expected.  With so many of the hurdles to raising rates now clear, both the US dollar and Inflation bonds (TIPS) have started to rally.

Figure 4

Source: Bloomberg.com

But the future of US monetary policy and safe haven investing are but two of the factors which determine the path of gold.  Another factor is long term price action itself.  On a weekly time frame, the recent range expansion is but another leg in the consolidation of a bigger range expansion which occurred from January to July of 2016, as can be seen in the weekly chart below.  This could be somewhat of a complex potential inverse head and shoulders pattern, with the January 2017-July 2017 move being the right shoulder. A major reversal pattern like this on long term time frames take time to develop.

Figure 5

The current runup from July of this year took out a major trendline (seen in blue below) which gold prices happily touched several times in order to substantiate its validity. If we are at an important inflection point in gold, traders will need to position themselves ahead of a reversal, both short term and long term.  On the long term frame, a few scenarios are drawn below, with yellow being the most unlikely due to the lack of a properly proportioned inverse head and shoulder pattern…yet.

Figure 6

Charts by: Sierra Chart


 

All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only.  The views in this report reflect solely those of the authors and not necessarily those of CME Group or its affiliated institutions.  This report and the information herein should not be considered investment advice or the results of actual market experience.

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