Gold Could Surprise On The Upside

  • A pattern of lower highs since February
  • A bullish reversal on May 30 and a bearish pattern ends on May 31
  • Fear and uncertainty could drive sentiment
  • Central banks are buyers
  • Buying dips into a volatile June

I have been intimately involved in the global gold business since the early 1980s. I rose through the ranks at Philipp Brothers and Salomon Brothers to run the global precious metals business from 1989 through 1997. With almost two decades on the trading desk at one of the world’s leading bullion dealing house, and trading gold and other precious metals in the twenty-two years that followed, I have watched and participates in the ups and downs of the yellow metal for just shy of four decades.

Gold traded to a high at $875 per ounce in 1980, and it took twenty-eight years for it to rise to a higher high. After trading to a low of $252.50 per ounce in 1999, gold finally broke to the upside starting in 2003 when the price moved above the $400 level for good. However, it was not until the price reached a new high at $1033.90 in early 2008 and spiked lower to $681 during the financial crisis that it blasted off to the upside. Since 2009, the price has not returned to under $1000 per ounce. Gold hit a peak at $1920.70 in September 2011. Since then, the price corrected to a low at $1046.20 in December 2015. Since that low, gold has been trading in a range making higher lows.

Since February 2019, gold had been making lower highs, but that could have ended on the day that May came to a close.

A pattern of lower highs since February

June gold futures rolled to August last week, but the price action in the gold futures market has been bearish since August futures hit a high at $1361.50 per ounce on February 20. The continuous contract peak was at $1344 per ounce. The August peak was at a higher level because of contango or the forward premium in the gold market’s term structure. 

Source: CQG

Gold has been a frustrating trade from the long side of the market since February as every attempt at a rally failed. In late March, August gold futures made it up to a high at $1335.70 and failed. In mid-April, a lower high at $1320.70 led to a lower low at $1273.20. In mid-May, gold traded to another lower peak at $1310.10 when it ran out of buying and traded down to just under the $1275 per ounce level on May 21. In a sign that market participants are fed up with waiting for a rally in the gold market, open interest fell from 524,355 contracts on May 15 to 443,231 contracts at the end of last week, a decline of 15.5% in the total number of open long and short positions in the COMEX futures contracts.

Gold was in a bearish price pattern, and lots of longs closed their positions as June futures rolled to August over last week.

A bullish reversal on May 30 and a bearish pattern ends on May 31

While gold’s price pattern on the daily chart was bearish from February 20 through May 30, a little over three months, that changes on the second to last day of the previous month. The daily chart illustrates that the yellow metal put in a bullish reversal trading pattern on May 30. The price fell below the prior day’s low and closed the session above the May 29 high. On Friday, May 31, selling hit the stock market as President Trump announced he would slap tariffs on Mexico over the immigration and border issues. The rising fear and uncertainty propelled the price of gold higher as it followed through on the bullish reversal from the previous session. The price of gold moved higher, and more significantly; it broke the pattern of lower highs trading to a peak at $1311.90 on the August contract, which was $1.80 above the May 14 peak. The settlement price at $1311.10 was also above the mid-May high.

Price momentum and relative strength metrics turned higher, and daily historical volatility rose to just under the 10% level after moving below 6% at the beginning of May.

Fear and uncertainty could drive sentiment

The drop in the open interest metric was a sign that market participants abandoned long positions in gold out of frustration as June futures rolled to August. Rather than paying the premium for the roll because of contango in the gold market, many decided to cash in their chips and exit risk positions. The drop in open interest could mean that there is plenty of room for new buyers to come to the market as fear and uncertainty are rising in markets across all asset classes because of the latest chapter in protectionism with the US tariffs on Mexico. Moreover, the drop in the metric also means that the gold market is not overloaded with long positions, so a continuation of risk-off behavior in other markets is not likely to lead to selling in gold to raise cash. As of May 30, the open interest in the gold futures market is not far above its lowest level of 2019.

The price of gold moves higher or lower on sentiment. While the dollar index is close to its peak, bonds have rallied sharply, lowering the carrying cost and contango in the precious metal. Gold tends to thrive in low interest rate environments. At the same time, over recent weeks, risk-off periods in other markets has led to buying instead of selling in gold.

Central banks are buyers

Central banks, monetary authorities, and governments around the world hold gold as part of their foreign exchange reserves. Therefore, gold receives validation as a currency instrument from the official sector.

Decades ago, when I started in the gold trading business, South Africa was the leading producer of the yellow metal in the world. Russia was also a significant producer and constant seller of the metal in the 1980s, 1990s, and the early years of this century. Today, China is the world leader when it comes to production. Both the Chinese and Russian governments have been increasing their strategic gold reserves as they accumulate domestic production. China, Russia, and other countries around the world have also been buying gold on the international market to further increase their holdings and the percentage of gold versus other foreign currency reserve assets. Central banks continue to be net buyers of gold. Over the first three months of 2019, central banks bought 145.5 tons of the yellow metal, which was the highest level in six years and 68% higher than the same period in 2018. In 2018, the official sector was a net buyer of over 253 tons according to the World Gold Council. At the current pace, they will buy more in 2019 compared to last year.

Given the current trend where many governments prefer holding gold to other global reserve currencies, any selloff in the gold market could increase the official sector’s appetite for the metal. At the same time, the rise of Bitcoin and other digital currencies over the recent weeks is a sign that faith in central banks and government is declining. Gold tends to thrive when sentiment shifts and market participants look for safe-haven assets.

Buying dips into a volatile June

Even though gold closed on a bullish note end the end of May, the pattern of trading in 2019 suggests that another selloff and more disappointment could be on the horizon for the gold bulls. However, while the trend of lower highs and lower lows dominated trading so far this year, every significant dip has been a buying opportunity in the yellow metal.

June is likely to be a volatile month is markets across all asset classes. The spread of protectionism may have ignited a period of fear and uncertainty not seen in markets since 2008, when the financial crisis gripped the world. Central banks flooded the globe with unprecedented amounts of liquidity through artificially low rates of interest in the short-term and quantitative easing programs that injected put options under bond markets. Governments can run printing presses and produce legal tender that has only the full faith and credit of the issuer, but there is a finite amount of gold stocks on the earth and a limited amount of production each year. One of the most compelling arguments for gold and against foreign exchange instruments is the trend in gold in US dollar, euro, yen, yuan, ruble, and almost all currency terms since the turn of this century. I continue to buy the yellow metal during periods of price weakness as I believe a break above the post- Brexit 2016 peak at $1377.50 and the 2011 all-time high at $1920.70 is inevitable.