Introduction
After almost 4 years, gold bulls finally got the breakout they have been waiting for. Last week, gold was finally able to break out above its multi-year resistance zone.
It has been a volatile ride since the previous three attempts all failed, leading to significant declines in the price.
In March 2023, I warned that it was probably too early for a breakout, see here.
I also was not getting bullish in December 2023 because of reasons I explained in May last year, see here.
However, last month, I started to see that things were changing from both a fundamental viewpoint (see here) and from a sentiment standpoint (see here).
Of course, I didn't get every move right. Between those 'almost breakout points' I sometimes tweeted that an interest set-up could start to form on the upside or downside. Some worked, some didn't. But at the times that really mattered, when gold was looking to break out, my analysis has been spot on if you ask me.
Please note that this is not a victory lap at all. I'll be the first to admit that my view on equities has been dead wrong from a fundamental viewpoint.
But that's no shame. We are here to make money, not to predict the future.
If one of the greatest macro traders/investors ever wasn't able to predict what was going to happen, should we think about ourselves that we can?
Soros: "My financial success stands in stark contrast with my ability to forecast events.
…Even in predicting financial markets my record is less than impressive."
Is this the real breakout?
As I explained in the introduction, I think it is. Fundamentals have changed (closing in on the rate cutting cycle) and sentiment was a lot less bullish coming into this breakout. I remember the earlier fake breakouts. Everyone was talking about gold, that's not the case now. We can see it in GLD flows and futures positioning as well.
Gold is very overbought right now but this is a positive thing longer term. The table below shows that the average gain in 6 months is another 8%. However, this average gain includes the 4 periods when the gold price declined. If we exclude those, the average gain is much higher at around 17,2%.
Source: Bespoke Invest
Can we just exclude those 4 periods and how do we know we won't experience one of those negative outcomes again?
The chart below indicates the four periods when we saw a negative return after the price being extremely overbought. In 2011 and 2020, we just had seen a multi-year rise in the price and the weekly RSI was extremely overbought. Right now, the move has only just started so we can't compare these periods. In 2015, we were stil in a downward trending market. This is also different to today since we just broke out from a multi-year consolidation. In 2022, the extreme overbought level came because investors were buying in panic because of the start of the Russia-Ukraine war. Again, not comparable to today since the price is breaking out without the help of an external shock or overwhelming bullishness/panic-buying.
So, if you ask me, I don't think we'll have one of those negative outcomes.
This breakout is the real deal. Price, fundamentals and sentiment are confirming it.
What's next?
What will happen next? Will the price continue its steep rise from the last two weeks without looking back? Will we see a consolidation first or maybe a retest from the breakout?
Let's start with the big picture by looking at a weekly chart. (Please don't give too much attention to all the horizontal support/resistance levels, some may indicate daily levels, other weekly levels, just focus on the top line which shows the weekly resistance zone.)
We see a very strong breakout candle in combination with a weekly RSI around the 70 level. If you look back at 2019, just when gold broke out from its base that formed between 2013 and 2019, the RSI was at a similar level. The breakout just started and continued for several months. So, on the weekly timeframe the breakout is confirmed and there is a lot of room to run higher.
Let's now look at the daily timeframe. The RSI is very overbought. In fact, it's just as overbought as it was after the initial rally after the 2019 breakout. In 2019 we saw a 6,4% rise from the breakout level. Right now, we saw a 5,6% rise. So, the price action is rather similar. (You can see the percentage gains from the breakout level in 2019 and right now indicated in green on the chart below.)
What followed in 2019 was a 4 to 5 week consolidation where the price declined 2,8% from its highest closing price from that initial move after the breakout. If the same would happen today (assuming Friday's close is the highest closing price in this initial move higher), gold could correct to around 2117 USD.
But, and this is very important, the extreme overbought RSI was a sign of strength, not one that should give you the idea you need to sell. Because what happened next is that gold regained its small loss from the consolidation and then rose an additional 9%. If the same happens today, this would bring us eventually (after the consolidation) to 2374 USD.
The next chart shows the other periods when gold reached a similar overbought level as now during the 2019-2020 bull market. In early 2020 we saw another consolidation where the price declined 2,3%. Again, the overbought level wasn't a sign to exit, it just was a signal that gains needed to be digested by the market. Afterwards, the gold price continued its journey higher. In the summer of 2020, after the breakout above the 2011 high, the overbought level didn't matter until it did. It eventually market the top of the bull run but not before the price rose another 6%.
But there is one very big difference between the cases analyzed above and the current situation. We are currently seeing a breakout above all-time highs after a multi-year consolidation. The cases above took place when gold was still trading below its previous all-time highs of 2011. This is an important difference. There are no natural resistance levels anymore right now, there were in 2019-2020.
So maybe it could be interesting to look at the breakout that took place in 2009. This breakout was, just as now, a breakout to new all-time highs after a lengthy consolidation. In 2009, the initial rise from the breakout was almost 19%. Compare this to the current rise of 5,6%. If we would see something similar happen today, the gold price would rise to 2410 USD before a correction starts.
How likely is it this will happen? First we must note that the price is now already just as overbought (on a daily timeframe) as it was in 2009 after the initial rally. This despite the current rally being much smaller. However, if we look at the weekly timeframe, the RSI stood at 80 in 2009 whereas it just stands at 70 today.
Looking at some of the other times when the daily RSI was just as overbought as it is right now, we can see the following.
In 2016, after the initial rise from its December 2015 bottom, gold got very overbought. What followed was a multi-month consolidation whereafter new highs followed. The maximum decline was 3,85%.
In 2010 and 2011, when gold reached similar overbought readings, the price corrected 4 to 6%. In late 2009 however, gold declined more than 13%. But this was after the very strong initial rally after the breakout we discussed earlier. The weekly RSI was much more overbought than it was now.
So, the weight of the evidence suggest to me that a consolidation with a max drawdown of around 3% seems to be expected. After that, the gold price will move significantly higher. The more negative cases we saw are not comparable to today because the moves that preceded them are not comparable to now or because they happened in a different part of the cycle.
Are we sure there will be a consolidation/correction?
No. And the reason can be found in the breakout that took place at the end of 2002. After a consolidation of 3 years, gold was finally able to break out of its base. The initial rally was around 16%. The daily RSI got just as overbought as now but only a 2% intraday correction took place. There was no multi-week consolidation, just a one day correction. At the peak of the move, the weekly RSI reached 80, much higher than where it is today. If the same happens again, this would bring us to around 2400 USD.
This case looks similar to the 2009 breakout we discussed earlier. The initial price gains after the breakout are much higher than now. Prices both peaked when the weekly RSI was at around 80. In 2009 the daily RSI stood at the same level as it is right now when the price peaked. However, and this is a difference, in 2002 the price kept rising when it stood at the daily RSI it is now.
Conclusion
So, where does that leave us?
I think there are two possibilities:
We are close to a local high in gold. From that high, we'll see a multi-week consolidation where the price correction will be limited (around 3%). After this consolidation, gold can continue its rise higher.
The price continues its steep rise just like in 2002 and 2009. This could bring us to a price target of 2400 USD without a consolidation or meaningful correction. Important to note with this scenario is that in both cases, gold saw a severe retest from the breakout level after the rally was done. This means that once we are at 2400 USD, we should expect the price to decline again to around 2060 USD, a correction of around 14%. After this steep correction gold can continue its rise higher.
So, which one of these two will it be? I don't know. But now that we have a view about the most probable outcomes, we can see how we should trade around these.
If scenario one unfolds there is nothing for me to do. I've got a (leveraged) position in gold. I'll just sit through the consolidation with the possibility to increase my exposure as the consolidation takes hold.
If scenario two unfolds there is currently nothing for me to do. But there will be a lot to do when the price reaches its target of around 2400 USD. At that point I'll sell the entire position with the idea of getting back in at significantly lower prices.
If scenario one unfolds and we eventually reach 2400 USD (after the consolidation), I don't expect the price to fall all the way back to the breakout level.
So, gold has two options. Either it moves sharply higher right now after which we'll see a very sharp retest. Or we take the more orderly route by having a consolidation now after which the price can rise again.