Another eventful couple of weeks have passed, and I think we can all agree that everyone now has a clear understanding of where we are with respect to the economic policy being pursued by the US Federal Reserve. Oh no hold on, that’s the alternate world. In this one investors are going bald from all the head scratching – in a way it is lucky we all bit our nails down to stubs in the run up to the announcement.

In a recent article I wrote, my opinion was that the Fed would not raise rates and gold would rally in the wake of the announcement. That expectation played out well and gold moved higher briefly hitting $1156, but now that we have moved through my primary support region at 1114-1122, I feel there is a chance we head back to the lows. A nice bullish short term trade but nothing more than that.

One of the big talking points in my trading room this week was the reaction and subsequent performance of the US Dollar (UUP) in the days following the decision to abort ‘liftoff’. Given that a number of Fed officials gave tacit consent to delay a hike into 2016, many expected the dollar to head back to the 90/91 level, but instead the dollar held the ideal support region on my chart (94.1-94.6) and has since blasted off to the upside.

I believe there is good reason for that strong dollar performance, and I believe it will influence our gold rally in the next few weeks, but before I come on to that topic I thought it might be useful to review the daily chart and answer a question I have been asked a lot recently:

Has Gold Made The Low? 

It will probably sound stupid to say this (bear with me for a few paragraphs) but that is not the question you should be asking at this stage – a better question if you are itching to buy gold and the gold miners is whether or not gold is in an uptrend or a downtrend, since you should only really look to buy when an uptrend is confirmed. Why risk your investing capital until you know it is safe to do so?

Since an uptrend is defined as a series of higher lows and higher highs, you first need to see a higher high on the daily chart and if the subsequent retracement holds the previous low only then do you have the chance of confirming the change in trend. You can see this concept on many charts but I have produced an example focusing on the S&P500 during the 2008 crash and subsequent 2009 bear market low:

Now contrast that with a chart of GLD and ask yourself if we are in an uptrend or downtrend. Is it wise to risk your long term investment capital just yet? What would we need to see in order to confirm the low in place?

Now don’t get me wrong, we all want to buy the exact low and make as much return as possible when the bear market in gold ends and the bull market resumes, but it would be prudent to look for evidence of trend change if you are an investor wishing to put your capital to work safely. You won’t miss out on much by waiting for that ‘higher low’ to form and buying the breakout.

Every time gold rallies $50 higher the ‘low is in’ articles come out in spades, but since the fundamental landscape is no different today than it was 3 weeks ago, and since we don’t have any chart/price evidence to back that up, how could they possibly know? In the end their analysis amounts to nothing more than a guess that this time the low might be in - smart money does not invest like that and you shouldn’t either. 

I like to note what I would want to see in terms of the fundamental backdrop that may mark the change in trend, and when I see evidence of this I will write an article pointing it out, but for now all talk of the bear market low being in place is premature and possibly dangerous since there is a good chance we have further to fall.

Fed To The World – We Have A Big Problem

They say the road to hell is paved with good intentions, and I am more than sure that the Federal Reserve has only the best in mind for us all when they form their policy decisions, but in this particular instance I feel that failing to raise the base rate at their last meeting was a big mistake.

For the last couple of years we have been told that the decision to ‘normalise’ interest rates is data dependent, and when unemployment or wage growth reaches a certain level they will start to tighten, but their targets have mostly been met and even exceeded (admittedly inflation has never reached the 2% level they target) and yet here we are still at ZIRP. At some point the market will wake up and realise that there must be a bigger underlying problem in the global economy feeding their reticence to take action, and I think that realisation point came in the wake of their announcement and subsequent press conference.

In the last 6 months we have seen a very public request from IMF Chief Christine Lagarde to the Federal Reserve asking them to delay raising rates, and they indeed delayed up until this point in time, but the market was fairly ready for action this time around (even if it wasn’t fully priced in) and most of the rhetoric leading up to the decision was in the ‘just get on with it’ vane. This was a perfect opportunity to do just that.

You could argue that the Fed fear further strength in the dollar and the effect that a rate hike would have on potentially fragile overseas economies and their decision is therefore sound, but by failing to take action they have now confirmed the suspicion that overseas economies are very fragile and investors should be wary. Cue the exodus away from these economies and into the outwardly appearing healthy US economy, and the Fed may have just triggered the dollar rally they seem to fear. 

Data Points

COT

 The latest data from the commitment of traders report is below:

Here we can see that after a period of status quo between the speculator and commercial categories the speculators have started to chase price higher by closing out a decent amount of their short contracts and adding a fair few long contracts.

However, the level at which they have been buying/selling recently has dipped and this is reflected in the Open Interest stats which have been on the decline over the last few months. People are starting to lose interest in gold, something we want to see for a low to form, and belief in the rallies is also on the wane.

If we compare the difference in speculator positioning during the November 2014 to January 2015 rally we can see that they accumulated long positions throughout, even when gold pulled back in December 2014. This time around they are quick to jettison their purchases at the first sign of trouble, showing that they are not as confident in the longer term prospects for gold.

Remember that we are looking for this category to get extremely net short and provide the fuel for the first wave higher when they all run for cover – smart money doesn’t try to catch falling knives – which is another reason I expect a further sharp drop in the gold price (they can then chase) before the bear market low is made.

GOFO

Backwardation occurs when the gold spot price is higher than the prices given for gold futures contracts, and means that a holder of physical gold can sell bars at the spot price and buy back the same amount of gold at a cheaper price via futures contracts. The physical gold holder then saves money on storage and insurance costs, and can elect to have their physical gold returned to them at a future date.

The fact that physical gold (spot) is trading at a premium to paper gold (futures) implies that there is a scarcity of physical gold on the market, or there is excess demand for physical gold that is not currently being met, so traders look to these figures to get a feel for gold supply and demand levels as, in general, less supply or more demand will equate to a rising price.

Since the LBMA discontinued publishing data on backwardation I have been following the supply and demand report at Monetary Metals, and the last report showed something quite interesting in that we had backwardation in place with gold at $1100, but by the time it had rallied to $1150 it had all disappeared sharply.

From this was can glean that with gold at $1100 there was not enough sellers of the physical metal to meet demand, but at $1150 there was suddenly plenty of available metal for sale – the question is did all the buyers dry up at $1150, or did someone use the opportunity to sell into the rally? In my opinion the answer is more likely to be option 2, meaning bulls should be careful as there may be overhead supply to deal with on any further rise in the price.

US Dollar

As discussed further up I feel there is now the potential for wave iv to have completed, and the dollar is now on the cusp of a strong move to new highs in the 103-106 range. We have held perfect support levels on each retrace so far (including the Fed induced downside spike) and to confirm the low I am now looking for a rally that takes us above the red declining trend line on the 4 hour chart below:

We can see there is a small gap to fill at 96.12 but as long as we now hold above 94.18 and more ideally above 95.16, we may well see a very strong, very fast move higher over the course of the next month. If this plays out it will put pressure on the gold price, and may mean the end of the rally altogether. Gold bulls should be watching the dollar carefully in the coming few weeks.

The Gold

Gold has played out quite nicely over the last couple of weeks. We made the low at 1098 which was $3 above my minimum target and we got the rally I was expecting. Since then we have failed to hold ideal support at 1114-1122, and I have been recommending a short trade to the guys in my trading room on any retrace, in fact we entered short this morning at 1118 with a stop at 1123 and a target in the 1080-1100 region (more aggressive traders bought dust at this morning’s low).

If we can now hold the target region (lower blue box) over the next couple of weeks, we still have the potential for a rally higher towards $1200 to complete the current wave, but any move below that zone is likely to trigger a sharp decline to 1031 at a minimum.

Overall I am bearish on gold and expect lower lows over the next 6 months, but should support hold we still have the chance for one final pop to the upside prior to that decline taking place. 

Short Term Support = 1102, 1090 & 1082

Short Term Resistance = 1123, 1135 & 1140

I wish you all good luck for the coming week!