Please read the Disclaimer before reading this article.
Introduction
Let's talk about gold.
In the middle of January, I warned that a correction was getting close, see here.
A correction came indeed and I highlighted an interesting risk/reward point to re-enter the trade in the mining shares, see here.
This level was breached two weeks ago, providing an excellent entry point. (see here)
I didn't expect this level to be breached this fast but price action is king.
The violent move up in gold started two weeks ago. I was more cautious and didn't expect this move higher.
After the violent move higher, I saw some potential warning signals last week, see here.
In this article I want to discuss two things:
1) The potential danger for gold if this move higher was because of an excessive reaction to banking fears.
2) The behavior of gold around all-time highs.
Gold - interest rates - banking fears.
After gold peaked in 2011 and saw a multi-year bear market, the gold market really took off at the end of the previous rate hiking cycle at the end of 2018. (We saw a mini bull run in 2016 but this was part of the bigger basing process.)
Interest rates peaked (black line on the chart below) and gold rose from 1200 USD to 2000 USD. When interest rates bottomed in the middle of 2020, gold started a long bear market/consolidation.
In my opinion, we saw the peak in long-term interest rates in October last year. This tightening might also be over or in any case, I think it's clear to everyone that we are very close to the end.
This is why gold has been behaving so well. I'm very bullish on gold for the next 18 months.
However, I'm not so sure if I'm bullish for the next few weeks.
From the beginning of March until now, the 10 year yield declined very rapidly from 4,06% to 3,4%. The worry I have is that this move was possibly caused by speculators being record short bond futures (see here). Once the problems in the banking sector became apparent, these positions got caught off guard and that's why interest rates declined so violently. It's also why gold rose so fast.
Panic buying is never a good idea. I remember last year when Russia invaded Ukraine and gold shot to higher to 2050 USD. Back then, just as now, people were calling for a breakout above all-time highs and the beginning of a new bull market.
We know they were completely wrong last year.
I think they'll be right this year (on an 18 month timeframe) but I'm not convinced that today is the moment to become extremely bullish on gold.
If we look at the 10 year yield on a weekly timeframe, we can see that it's back to a very significant support level.
The daily chart also shows the significance of this level. This past week generated two reversal candles right on this support level. If this level breaks, the bull market in gold is really back. If interest rates move higher, expect a correction in gold.
To be clear, given my bearish view on the US economy, I'm expecting this level on interest rates to fail in 2023 (see here). As stated earlier, I therefore also think gold will break above all-time highs.
But what if the decline in interest rates is indeed excessive and what if these reversal candles on the 10 year yield show that it's too early to expect a breakdown in yields?
Buying bonds or gold is never a good idea when the move higher is caused by panic buying (being it a banking panic or the start of a war).
What can cause interest rates to go higher in the coming weeks? Consider the two points below:
1) The realization that not every bank is at risk of collapsing and that Deutsche Bank is not necessarily the next Credit Suisse (see for example here, here, and here). If panic subdues, interest rates can go higher again. (Given my bearish view on the economy, I think credit problems will continue to become more prevalent as we continue throughout the year. However, the question is if sentiment is too bearish or not on this credit risk right now.)
2) The realization by the market that it's being too aggressive pricing in rate cuts. I think there is a window of opportunity for inflation to surprise to the upside again as the following chart by Francois Trahan shows. (Please note that these are tactical opinions to optimize my entry points. Big picture, I'm bullish gold for the next 18 months.)
Source: Trahan Macro Research
The combination of these two elements can cause a move higher in interest rates from the current support level, thereby putting pressure on the gold price.
I might be completely wrong on this but looking at the panic buying in call options for gold, I think it's important not to blindly buy because other people are panicking and screaming new highs are imminent.
Source: FT, Bloomberg
Gold price action around all-time highs.
Gold has reached new all-time highs in both the Euro and GBP. Lot's of people are saying this is a sign of new all-time highs coming for gold in USD as well. I agree with this.
However, history shows that it can take some time for gold in USD to follow the price action in the Euro and GBP.
The following chart shows gold in the three different currencies. The red vertical lines show when gold peaks. As you can see, in 2008, 2011 and 2020, gold peaked in all three currencies simultaneously.
The vertical green lines show when gold breaches out of its resistance zone and reaches new all-time highs in the different currencies. It's interesting to note that there can be quite a big time gap between this happening in the Euro/GBP and the USD.
So yes, I think gold will reach new all-time highs in the USD. But, I wouldn't take the price action in the Euro and GBP to rationalize that this move is imminent.
Another important point I would like to make is the historical price action of gold when it's preparing to break out above all-time highs.
The chart below shows the 1978 breakout in gold above its 1974 all-time high.
As you can see, the price consolidated a few weeks right below the breakout level before actually making the move higher (last blue arrow).
In 2007, gold moved above its 1980 all-time high. Again we see a consolidation of multiple weeks (black arrow) below the breakout level before the actual breakout took place.
In 2009, when breaking above its 2008 all-time high, there was again a consolidation of multiple weeks (last black arrow) right below the resistance level.
And if we look at the breakout in 2020 above the 2011 all-time highs, once again we see something similar. Price consolidated for multiple weeks before making its move.
When we look at the current situation below, we can see that the gold price is getting very close to breaking above its former all-time high resistance level. Will it just blast through this level without any problem? History suggests that a multi-week consolidation wouldn't be abnormal before the actual breakout takes place.
When looking at the breakout above the 2013-2018 basing pattern, we can see that gold consolidated multiple weeks before breaking out. This despite interest rates declining during this consolidation.
Looking at the breakout above the 1560 level, we can also see that a multi-week consolidation took place while interest rates rose.
Taking everything together, it wouldn't surprise me to see gold consolidating around these levels before making its big move higher.
Admittedly, the potential resistance zone is rather big (1980-2066USD).
It will therefore be less clear when the actual breakout took place. In previous breakouts above all-time highs, this level was more clear.
I must also admit that my view on bonds can be completely wrong (like every view I have for that matter). I'm looking for potential higher interest rates for the next few weeks. For the next few months however, I'm a bond bull so if yields break down, I'll need to act.
I'll let me guide by the price action, as Jesse Livermore noted: “Markets are never wrong - opinions often are.”