In our globalized economy, currency pairs have a negative correlation with gold, so how does the current EUR/USD situation impact the yellow metal?

It pays to pay attention to what is happening in Europe. As is well known, there are many currency pairs in the world, but the most traded one is the EUR/USD. How does that affect you as a gold investor? The equation goes something like this: if the economy of the Eurozone sinks and takes the EUR down with it, the USD rises – and vice-versa. Gold, which is usually inversely related to the dollar, will also either rise or decline based on the latter’s behavior.

Before we get to Europe though, let’s take a look at what gold is currently doing.

Once again, yesterday’s (Jan. 26) session was relatively uneventful on the technical front, but that doesn’t mean that the outlook is any more bullish.

Conversely, it remains bearish because of multiple developments that happened before the current pause. For instance, the invalidation of gold’s breakout above its 2011 high. Even though it had help from a sliding USD Index, the yellow metal still failed to hold above this critical support level.

It seems that the only thing that made gold rally in the recent past was the U.S. inauguration-based uncertainty. As it fades away, gold is losing its gleam. In fact, the previous relative weakness seems to have already returned.

Figure 1 – USD Index futures (DX.F)

Taking the previous two days into account (precisely: yesterday and today’s pre-market trading), we see that the USD Index declined. In such a situation, gold should have rallied or at least paused, but what did it do?

Figure 2 - COMEX Gold Futures (GC.F)

Gold declined. This means that gold’s weakness relative to the USDX is back.

Looking at the above chart, I marked the November consolidation with a blue rectangle, and I copied it to the current situation, based on the end of the huge daily downswing. Gold moved briefly below it in recent days, after which it rallied back up, and right now it’s very close to the upper right corner of the rectangle.

This means that the current situation remains very similar to what we saw back in November, right before another slide started – and this second slide was bigger than the first one. Consequently, there’s a good reason for gold to reverse any day (or hour) now.

Let’s get back to the USD Index for a minute.

I think that the USD Index is likely to rally in the following weeks, but as far as the next several days are concerned, the situation is relatively unclear.

The USD Index finds itself after the breakout above the declining medium-term resistance line, but it’s also after a breakdown below the rising short-term support line. Consequently, it’s very short-term outlook is relatively unclear. In all cases, I don’t see it moving visibly below the previous 2021 low.

And since the situation is unclear with regard to the short-term in case of the USDX, it would be natural for gold to hesitate. Since it’s already declining, it seems that even if the USDX tested its previous 2021 low, gold would not rally far.

Figure 3 - COMEX Silver Futures (SI.F)

Similarly to gold, silver is not doing much. The white metal is moving back and forth after the big January slide and it seems to be preparing for another move lower.

Let’s keep in mind that silver has a triangle-vertex-based reversal in late February – close to Feb. 23. Based on what we’ve seen so far, it seems quite likely that it will be a major bottom (not likely the final one for this slide, though).

Figure 4 - VanEck Vectors Gold Miners ETF (GDX)

Miners didn’t do much yesterday either, so my previous comments on them remain up-to-date. To explain the pattern, I wrote on Jan. 11:

If you analyze the chart above, the area on the left (marked S) represents the first shoulder, while the area in the middle (H) represents the head and the area on the right (second S) represents the potential second shoulder.

Right now, $33.7-$34 is the do-or-die area. If the GDX breaks below this (where the right shoulder forms) it could trigger a decline back to the $24 to $23 range (measured by the spread between the head and the neckline; marked with green).

And after analyzing Thursday’s (Jan. 21) price action, I wrote the following (on Jan. 22):

As far as the miners are concerned, mining stocks didn’t correct half of their 2021 decline. They didn’t invalidate the breakdown below the rising support line, either. In fact, the GDX ETF closed yesterday’s session below the 50-day moving average. Technically, nothing changed.

Regarding the GDX ETF’s current consolidation pattern (November to present), it mirrors what we saw between April and June of last year (the shaded green rectangles above). 

I added:

Both shoulders of the head-and-shoulder formation can be identical, but they don’t have to be, so it’s not that the current consolidation has to end at the right border of the current rectangle. However, the fact that the price is already close to this right border tells us that it would be very normal for the consolidation to end any day now – most likely before the end of January.

If we see a rally to $37, or even $38, it won’t change much – the outlook will remain intact anyway, and the right shoulder of the potential head-and-shoulders formation will remain similar to the left shoulder.

But with many paths to get there, is hitting $37 or $38 a prerequisite to the eventual decline? Absolutely not. The GDX ETF could reverse right away and catch many market participants flat-footed. 

Remember, it’s important to keep last week’s rally in context. Despite the Yellen-driven bounce, the GDX ETF is still down considerably from its January highs.

Having said that, let’s take a look at the market from a more fundamental angle.

The Widening Economic Divergence

For weeks, I’ve been highlighting the economic malaise confronting the Eurozone. And like a fork in the road, the U.S. and Europe continue to head in opposite directions. More importantly though, the fundamental fate of the two regions, and the subsequent performance of the EUR/USD, will go a long way in determining the precious metals’ destiny.

Figure 5

If you analyze the chart above, you can see that gold and silver tend to track the performance of the EUR/USD. And while gold bucked the trend on Tuesday (Jan. 26), silver still remains a loyal follower. Thus, as the European economy sinks further into quicksand, its relative underperformance is likely to pressure the EUR/USD and usher the PMs lower.

On Friday (Jan. 22), the IHS Markit Eurozone Composite PMI fell to 47.5 in January (down from 49.1 in December), with services falling to 45.0 (from 46.4) and manufacturing falling to 54.7 (from 55.2).

Please see below:

Figure 6

To explain, PMI (Purchasing Managers’ Index) data is compiled through a monthly survey of executives at more than 400 companies. A PMI above 50 indicates business conditions are expanding, while a PMI below 50 indicates that business conditions are contracting (the scale on the left side of the chart).

In contrast to the Eurozone, the U.S. Composite PMI rose to 58 in January (up from 55.3 in December), with services rising to 57.5 (up from 54.8) and manufacturing rising to 59.1 (up from 57.1).

Figure 7

In addition, after European Central Bank (ECB) President Christine Lagarde revealed (on Jan. 21) that the Eurozone economy likely shrank in the fourth-quarter (all but sealing a double-dip recession), Germany (the Eurozone’s largest economy) cut its 2021 GDP growth forecast from 4.4% to 3.0%.

And not looking any better, the International Monetary Fund’s (IMF) World Economic Outlook Report – which covers IMF economists' analysis over the short and medium-term – has the U.S. economy expanding by 5.1% in 2021 versus only 4.2% for the Eurozone. More importantly though, the Eurozone economy is expected to contract by 7.2% in 2020 versus 3.4% for the U.S. As a result, Europe has to dig itself out of a much larger hole.

Please see below:

Figure 8

Also noteworthy, the IMF downgraded its GDP growth forecast for Canada. And because the USD/CAD accounts for more than 9% of the movement in the USD Index (though still well below the nearly 58% derived from the EUR/USD) it’s an important variable to monitor.

Continuing the theme of Eurozone underperformance, U.S. consumer confidence (released on Jan. 26) rose from 87.1 in December (revised) to 89.3 in January (the red box below).

Figure 9 - Source: Bloomberg/ Daniel Lacalle

In contrast, Eurozone consumer confidence (released on Jan. 21) retreated in January. And while both regions’ readings are still well below pre-pandemic levels, currencies trade on a relative basis. As a result, the relative underperformance of the Eurozone is bearish for the EUR/USD.

Figure 10

If that wasn’t enough, the ECB essentially admitted it wants a weaker euro. On Tuesday (Jan. 26), reports surfaced that the ECB will investigate the causes of the euro’s appreciation relative to the greenback. Translation? The central bank is studying ways to devalue the currency.

Adding more fuel to the fire, the yield differential between the U.S. and Europe foretells a higher USD Index. Dating back to 2003, after the U.S. 10-Year Treasury yield troughed and began rising, the USD Index (except for 2008-2009) always followed suit.

Please see below:

Figure 11 - Source: Daniel Lacalle

In contrast, if you analyze the area at the bottom, you can see that the U.S. 10-Year Treasury yield has bounced by 57 basis points from its August low. But moving in the opposite direction, the USD Index is lower now than it was it August.

Furthermore, notice the large divergence that’s occurred since the beginning of December?

Figure 12

The abnormal behavior above highlights the power of sentiment. Because U.S. investors ‘want’ a lower USD Index, they’re willing to overlook technicals, fundamentals, historical precedent and essentially, reality. However, if the dynamic reverses, the USD Index is ripe for a resurgence.

Circling back to the euro, the currency is already starting to crack. On Monday (Jan. 25), I wrote that Janet Yellen’s pledge to “act big” on the next coronavirus relief package ushered the EUR/GBP back above critical support.

However, on Tuesday (Jan. 26), the key level broke again.

Please see below:

Figure 13

More importantly though, a break in the EUR/GBP could be an early warning sign of a forthcoming break in the EUR/USD.

Figure 14

If you analyze the chart above, ~20 years of history shows that the EUR/GBP and the EUR/USD tend to follow in each other’s footsteps. As a result, if the EUR/GBP retests its April low (the next support level), the EUR/USD is likely to tag along for the ride (which implies a move back to ~1.08).

Figure 15

And like a falling string of dominoes, if the EUR/USD retests ~1.08, the PMs should come under significant pressure.

Figure 16

If you analyze the chart above, you can see that over the last ~20 years, gold and silver tend to live and die with the EUR/USD. Naturally, there are also other factors, but the point is that the performance of this currency pair shouldn’t be ignored. As a result, a euro collapse (or at least a significant decline in it) could deliver plenty of fireworks. Conversely, once order is restored and weak Eurozone fundamentals are accurately priced into the EUR/USD, the precious metals will present us with an attractive buying opportunity.

Thank you for reading our free analysis today. Please note that the above is just a small fraction of the full analyses that our subscribers enjoy on a regular basis. They include multiple premium details such as the interim targets for gold and mining stocks that could be reached in the next few weeks. We invite you to subscribe now and read today’s issue right away.

Sincerely,
Przemyslaw Radomski, CFA
Founder, Editor-in-chief

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Gold, silver, and miners all appear to be hesitating lately as the USDX seeks direction. As we very well know, because gold is more often than not inversely correlated to the USD, when the dollar is in doubt and doesn’t know where to go, neither does gold. But that’s not where the real news is. More importantly, it’s the prospect of a market bubble forming that should have investors concerned.

Gold dipped slightly in today’s morning trading and yesterday proved to be quite uneventful. Even though the USD index did move a bit higher, it seems that traders are not buying this week’s strength.

Figure 1 – USD Index (DX.F)

And I don’t blame them, because it doesn’t look convincing to me, either. Don’t get me wrong – I think that the USD Index is likely to rally in the following weeks, but as far as the next several days are concerned, the situation is relatively unclear.

The USD Index finds itself after the breakout above the declining medium-term resistance line, but it’s also after a breakdown below the rising short-term support line. Consequently, it’s very short-term outlook is relatively unclear. In all cases, I don’t see it moving visibly below the previous 2021 low.

And since the situation is unclear with regard to the short-term in case of the USDX, it would be natural for gold to hesitate.

Figure 2 - COMEX Gold Futures (GC.F)

And that’s exactly what it’s doing.

Looking at the above chart, I marked the November consolidation with a blue rectangle, and I copied it to the current situation, based on the end of the huge daily downswing. Gold moved briefly below it in recent days, after which it rallied back up, and right now it’s very close to the upper right corner of the rectangle.

This means that the current situation remains very similar to what we saw back in November, right before another slide started – and this second slide was bigger than the first one. Consequently, there’s a good reason for gold to reverse any day (or hour) now.

And what happened last Friday (Jan. 22)?

Well, gold fell by 0.52% as the Yellen-led intoxication began to wear off. Gold also continues to decline in today’s (Jan. 25) pre-market trading, despite a small move lower in the USD Index.

Figure 3 - COMEX Silver Futures (SI.F)

Similarly to gold, silver is not doing much. The white metal is moving back and forth after the big January slide and it seems to be preparing for another move lower.

Let’s keep in mind that silver has a triangle-vertex-based reversal in late February – close to Feb. 23. Based on what we’ve seen so far, it seems quite likely that it will be a major bottom (not likely the final one for this slide, though).

Figure 4 - VanEck Vectors Gold Miners ETF (GDX)

Miners didn’t do much yesterday either.

If you analyze the chart above, the area on the left (marked S) represents the first shoulder, while the area in the middle (H) represents the head and the area on the right (second S) represents the potential second shoulder.

Right now, $33.7-$34 is the do-or-die area. If the GDX breaks below this (where the right shoulder forms) it could trigger a decline back to the $24 to $23 range (measured by the spread between the head and the neckline; marked with green).

And after analyzing Thursday’s (Jan. 21) price action, I wrote the following (on Jan. 22):

As far as the miners are concerned, mining stocks didn’t correct half of their 2021 decline. They didn’t invalidate the breakdown below the rising support line, either. In fact, the GDX ETF closed yesterday’s session below the 50-day moving average. Technically, nothing changed.

Regarding the GDX ETF’s current consolidation pattern (November to present), it mirrors what we saw between April and June of last year (the shaded green rectangles above). 

I added:

Both shoulders of the head-and-shoulder formation can be identical, but they don’t have to be, so it’s not that the current consolidation has to end at the right border of the current rectangle. However, the fact that the price is already close to this right border tells us that it would be very normal for the consolidation to end any day now – most likely before the end of January.

If we see a rally to $37, or even $38, it won’t change much – the outlook will remain intact anyway, and the right shoulder of the potential head-and-shoulders formation will remain similar to the left shoulder.

But with many paths to get there, is hitting $37 or $38 a prerequisite to the eventual decline? Absolutely not. The GDX ETF could reverse right away and catch many market participants flat-footed. 

Remember, it’s important to keep last week’s rally in context. Despite the Yellen-driven bounce, the GDX ETF is still down considerably from its January highs.

I recently received a question as to whether the H&S pattern is indeed symmetrical or not – i.e., are the shoulders really similar to each other.

In general, we will be able to better estimate that only after the GDX breaks below the neck level of the pattern (the dotted line). Until that happens, the formation is only a “potential” one and we don’t yet know how long the right shoulder will take to form. Based on yesterday’s (Jan. 25) closing price, the right shoulder is still “under construction”.

The green rectangles are identical (Figures 4/5) – I marked the left shoulder with it, and I copied and pasted it to the current situation. If the GDX breaks below the neckline this week, both shoulders will be identical or almost identical in terms of time.

Let’s take a closer look at the shape of these shoulders.

Figure 5 - VanEck Vectors Gold Miners ETF (GDX)

Each of them consists of five individual tops, with the middle one being particularly significant. The volatility is smaller this time, so the tops are not as clear, but they are still visible.

Moreover, when taking into account the current rising support line that was broken in mid-January, we see that it’s symmetrical to the declining support line that we saw in May and early June. The symmetry implies that the current breakdown would be symmetric to a “breakdown” that would have taken place if one moved backwards in time. This sounds esoteric, but it’s quite simple when one looks at what happened on the chart in mid-May. What preceded this “breakdown”? Consolidation, and before that we saw a rally and then some more back and forth movement. We see something symmetrical this time, so it all “fits”.

Naturally, the history will never repeat itself to the letter, but it seems that the above is enough to view both shoulders as being at least “similar”.

Regardless, the bearish implications will be in place only after we see a confirmed breakdown below the neck level. Until that happens, the bearish implications are only “potential”.

Having said that, let’s take a look at the market from a more fundamental angle.

Up, Up and Away!

Like pouring gasoline on a fire, I warned on Dec. 29 that record margin debt was fueling equities’ speculative frenzy.

I wrote:

Margin is used by investors to increase the amount of assets in their portfolio. Essentially, it increases their buying power. For example, if an investor has $100,000 in cash, he can borrow $100,000 and increase his portfolio holdings to $200,000 (50% margin). And in a nutshell, speculative investors use margin to increase their total returns.

However, like a double-edged sword, margin also increases losses when trades go south. At the same time, brokerages can issue a ‘margin call’ and force the investor to sell all of his holdings.

And while November’s data pegged monthly margin at $722.19 billion, in December that figure ballooned to an all-time high of $778.04 billion.

Please see below:

Figure 6 - Margin Debt to Economic Drawdowns Comparison (1999-2020)

If you analyze the chart above, you can see that each time margin debt swelled, a reversal occurred, with the eventual unwinding of excessive leverage which resulted in sharp and violent drawdowns.

To explain, notice how the S&P 500 moves in lockstep with monthly margin debt?

Figure 7

For context, the red line above depicts monthly margin debt, while the blue line above depicts the S&P 500. And like a scene out of The Exorcist, the S&P 500 is essentially possessed by the debt-driven binge.

Even more striking, notice how (from left to right) the previous highs in monthly margin debt actually preceded the dot-com bubble and the 2008 financial crisis? And considering where margin levels are today, those two drawdowns look like child’s play.

In addition, monthly margin debt has surged by 62% over the last eight months. Excluding today, a rush of this magnitude has only occurred four other times in history:

1. Aug. 1973: a bear market followed
2. Jul. 1983: a 14% decline followed
3. Mar. 2000: a bear market followed
4. Jun. 2007: a bear market followed

For context, a bear market occurs when an asset’s price declines by 20% or more.

Please see below:

Figure 8

To explain the chart above, the light blue line depicts the eight-month percentage change in margin, while the vertical red lines intersect with the S&P 500 at the above-mentioned dates. As you can see, three of the four occasions resulted in substantial declines – with the S&P 500 falling by 50% or more following the margin buildups in 1973, 2000 and 2007.

At the corporate level, it’s nearly identical. If you analyze the chart below, you can see that combined companies within the Russell 2000 index have (by far) the highest aggregate debt/EBITDA ratio when compared to other historical crises.

Figure 9

To explain, aggregate debt represents the combined principal and interest payments owed, while EBITDA is an acronym for earnings before interest, taxes, depreciation and amortization. Furthermore, because interest is paid before taxes (and depreciation and amortization are non-cash charges) lenders use EBITDA as a proxy for a company’s debt-service cash flow.

However, with aggregate debt liabilities nearly 13x their EBITDA, companies within the Russell 2000 are more levered now than ever. In addition, if you follow the three yellow arrows, during the dot-com bubble, the global financial crisis and the 2015/2016 oil crash, aggregate debt/EBITDA never even hit 9x.

As another sign of the debt binge, the riskiest companies are now able to borrow at the lowest interest rates ever. On Thursday (Jan. 21), the yield on CCC rated bonds hit an all-time low.

Please see below:

Figure 10

For context, Standard & Poor’s (S&P) classifies CCC bonds “as having significant speculative characteristics.” Furthermore, the U.S. ratings agency labels CCC companies as “dependent on favorable business, financial, and economic conditions.”

Please see below:

Source: S&P Global Ratings

In addition, and because yields and prices move in opposite directions, all-time low yields means that CCC bonds are now trading at their highest valuation ever. And considering we’re nowhere near “favorable business, financial, and economic conditions” does investors’ capital allocation behavior seem rational?

To summarize, the surge in speculation is likely to end similarly to other historical feeding frenzies. But more importantly, the precious metals will likely suffer as well.

Please take one more look at the above chart and note that the previous extreme low was somewhere in mid-2013. What does it signal for gold? Remember what happened then in gold, silver and mining stocks? Carnage.

Case in point? The percentage of NASDAQ Composite companies trading above their 200-day moving average is now at its highest level since 2004. Being long might not be the best investment idea at this time – at least with the medium term in mind.

Figure 11 - Source: Bloomberg/ Liz Ann Sonders

To highlight why averages exist in the first place, notice the identical pattern that emerged from 2009 to 2010 (the red boxes)? Following the 2008 financial (housing) crisis, U.S. equities bottomed in March of 2009. Several months later, euphoria took hold and the percentage of NASDAQ Composite companies trading above their 200-day MA surged back to record levels (near the end of 2009).

Another happy ending?

Not quite.

As valuations decoupled from reality, a Minsky Moment struck in early 2010, with the NASDAQ Composite plunging by more than 17% in just over two months.

Along for the ride, the NASDAQ 100 – the largest 100 companies in the index – also declined by nearly 16%.

Figure 12 – Nasdaq Composite Index

And circling back to the precious metals, the performance of the NASDAQ 100 is an important variable. If you analyze the chart below, you can see that the last five times the NASDAQ 100 declined by more than 2% in a single day – gold, silver and the gold miners all suffered significant drawdowns.

Figure 13

In conclusion, U.S. equities continue to walk the tightrope. And while their balance remains sure-footed for the time being, history suggests the eventual unwind will be quite spectacular. More importantly though, once the fall occurs, the PMs won’t be given a safety net. As a result, another move lower is likely to happen before an attractive entry point presents itself.

Thank you for reading our free analysis today. Please note that the above is just a small fraction of the full analyses that our subscribers enjoy on a regular basis. They include multiple premium details such as the interim targets for gold and mining stocks that could be reached in the next few weeks. We invite you to subscribe now and read today’s issue right away.

Sincerely,
Przemyslaw Radomski, CFA
Founder, Editor-in-chief

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Gold is suffering a hang-over after it’s early January highs, while the EUR/USD pair is buckling - so when gold declines, where will its bottom be?

After injecting itself with Janet Yellen’s stimulus sentiment, gold came down from its highs on Friday (Jan. 22).

And like the GDX ETF, it’s important to put gold’s recent run into context. For starters, gold is still trading below its August declining resistance line, it topped at its triangle-vertex-based reversal point (which I warned about previously) and the yellow metal remains well-off its January highs.

Figure 1

Looking at the chart below, we can see gold approaching the upper trendline of its November consolidation channel.

Figure 2

I marked the November consolidation with a blue rectangle, and I copied it to the current situation, based on the end of the huge daily downswing. Gold moved briefly below it in recent days, after which it rallied back up, and right now it’s very close to the upper right corner of the rectangle.

This means that the current situation remains very similar to what we saw back in November, right before another slide started – and this second slide was bigger than the first one. I wrote about this previously (Jan. 21), saying that there’s a good reason for gold to reverse any day (or hour) now.

And what happened last Friday?

Well, gold fell by 0.52% as the Yellen-led intoxication began to wear off. Gold also continues to decline in today’s pre-market trading, despite a small move lower in the USD Index.

Also adding to the upswing, one of the most popular gold indicators – the stochastic oscillator (see below) dipped below 20 last week. Itching to move off oversold levels, the yellow metal responded in kind. However, if you analyze the green arrows below (at the bottom of the chart), you can see that the first green arrow has a red arrow directly above it (marking gold’s November top).

Currently, the stochastic oscillator is right near that level, and with November acting as a prelude, the yellow metal could suffer a similar swoon in the coming days or weeks.

Figure 3 – Gold Continuous Contract Overview and Slow Stochastic Oscillator Chart Comparison

Back in November, gold’s second decline (second half of the month) was a bit bigger than the initial (first half of the month) slide that was much sharper. The January performance is very similar so far, with the difference being that this month, the initial decline that we saw in the early part of the month was bigger.

This means that if the shape of the price moves continues to be similar, the next short-term move lower could be bigger than what we saw so far in January and bigger than the decline that we saw in the second half of November. This is yet another factor that points to the proximity of $1,700 as the next downside target.

Moving on to cross-asset implications, Yellen’s dollar-negative comments tipped over a string of dominoes across the currency market. Ushering the EUR/USD higher, the boost added wind to the yellow metal’s sails.

Figure 4

And because the EUR/USD accounts for nearly 58% of the movement in the USD Index, the currency pair is an extremely important piece of gold’s puzzle. However, beneath the surface, the euro is already starting to crack. After breaching critical support last week, Yellen’s comments basically saved the currency, as a rally in the EUR/USD was followed by a rally in the EUR/GBP.

Figure 5

However, with Eurozone fundamentals drastically underperforming the U.S. (and many other countries as well), a come-to-Jesus moment could be on the horizon.

In summary, Friday’s detox – with the EUR/USD flat-lining and gold moving lower – could be a precursor to a rather messy withdrawal. Right now, the euro is hanging on for dear life, as technicals, fundamentals and cross-currency signals all point to a weaker euro. As a result, due to gold’s strong positive correlation with the EUR/USD, the yellow metal is unlikely to exit the battle unscathed.

So, why is gold likely to bottom at roughly $1,700 (for the interim)?

One of the reasons is the 61.8% Fibonacci retracement based on the recent 2020 rally, and the other is the 1.618 extension of the initial decline. However, there are also more long-term-oriented indications that gold is about to move to $1,700 and more likely, even lower.

(…) gold recently failed to move above its previous long-term (2011) high. Since history tends to repeat itself, it’s only natural to expect gold to behave as it did during its previous attempt to break above its major long-term high.

And the only similar case is from late 1978 when gold rallied above the previous 1974 high. Let’s take a look at the chart below for details (courtesy of chartsrus.com)

Figure 6 - Gold rallying in 1978, past its 1974 high

As you can see above, in late 1978, gold declined severely right after it moved above the late-1974 high. This time, gold invalidated the breakout, which makes the subsequent decline more likely. And how far did gold decline back in 1978? It declined by about $50, which is about 20% of the starting price. If gold was to drop 20% from its 2020 high, it would slide from $2,089 to about $1,671.

This is in perfect tune with what we described previously as the downside target while describing gold’s long-term charts:

Figure 7 - Relative Strength Index (RSI), GOLD, and Moving Average Convergence Divergence (MACD) Comparison

The chart above shows exactly why the $1,700 level is even more likely to trigger a rebound in gold, at the very minimum.

The $1,700 level is additionally confirmed by the 38.2% Fibonacci retracement based on the entire 2015 – 2020 rally.

There’s also a good possibility that gold could decline to the $1,500 - $1,600 area or so (50% - 61.8% Fibonacci retracements and the price level to which gold declined initially in 2011). In fact, based on the most recent developments in gold and the USDX (how low the latter fell without a rally in the former), it seems that $1,500 is more likely to be the final bottom than $1,700. The $1,700 level is likely to be a bottom – yes – but an interim one only.

Before looking at the chart below (which is very similar to the chart above, but indicates different RSI, volume, etc.), please note the – rather obvious – fact: gold failed to break above its 2011 highs. Invalidations of breakouts are sell signals, and it’s tough to imagine a more profound breakout that could have failed. Thus, the implications are extremely bearish for the next several weeks and/or months.

Figure 8 - RSI, GOLD, and MACD Comparison

The odd thing about the above chart is that I copied the most recent movement in gold and pasted it above gold’s 2011 – 2013 performance. But – admit it – at first glance, it was clear to you that both price moves were very similar. 

And that’s exactly my point. The history tends to rhyme and that’s one of the foundations of the technical analysis in general. Retracements, indicators, cycles, and other techniques are used based on this very foundation – they are just different ways to approach the recurring nature of events.

However, every now and then, the history repeats itself to a much greater degree than is normally the case. In extremely rare cases, we get a direct 1:1 similarity, but in some (still rare, but not as extremely rare) cases we get a similarity where the price is moving proportionately to how it moved previously. That’s called a market’s self-similarity or the fractal nature of the markets. But after taking a brief look at the chart, you probably instinctively knew that since the price moves are so similar this time, then the follow-up action is also likely to be quite similar.

In other words, if something looks like a duck, and quacks like a duck, it’s probably a duck. And it’s likely to do what ducks do. 

What did gold do back in 2013 at the end of the self-similar pattern? Saying that it declined is true, but it doesn’t give the full picture - just like saying that the U.S. public debt is not small. Back then, gold truly plunged. And before it plunged, it moved lower in a rather steady manner, with periodic corrections. That’s exactly what we see right now.

Please note that the above chart (Figure 8) shows gold’s very long-term turning points (vertical lines) and we see that gold topped a bit after it (not much off given their long-term nature). Based on how gold performed after previous long-term turning points (marked with purple, dashed lines), it seems that a decline to even $1,600 would not be out of ordinary.

Finally, please note the strong sell signal from the MACD indicator in the bottom part of the chart. The only other time when this indicator flashed a sell signal while being so overbought was at the 2011 top. The second most-similar case is the 2008 top.

The above-mentioned self-similarity covers the analogy to the 2011 top, but what about the 2008 performance?

If we take a look at how big the final 2008 decline was, we notice that if gold repeated it (percentage-wise), it would decline to about $1,450. Interestingly, this would mean that gold would move to the 61.8% Fibonacci retracement level based on the entire 2015 – 2020 rally. This is so interesting, because that’s the Fibonacci retracement level that (approximately) ended the 2013 decline. 

History tends to rhyme, so perhaps gold is going to decline even more than the simple analogy to the previous turning points indicates. For now, this is relatively unclear, and my target area for gold’s final bottom is quite broad.

Thank you for reading our free analysis today. Please note that the above is just a small fraction of the full analyses that our subscribers enjoy on a regular basis. They include multiple premium details such as the interim targets for gold and mining stocks that could be reached in the next few weeks. We invite you to subscribe now and read today’s issue right away.

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Przemyslaw Radomski, CFA
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Gold seems to be sleeping off its latest mini-rally and lacks the momentum to reach new highs. What happens from here? Has the USD bottomed? And what does it mean when we factor in the EUR/USD pair and poor economic indicators from Europe into the equation?

Not much happened yesterday (Jan. 21), but what happened was relatively informative. And by “relatively” I mean literally just that. Gold moved lower yesterday and in today’s pre-market trading, doing so despite another small move lower in the USD Index. The moves are not big, but they are meaningful. They show that gold’s inauguration-day rally was likely a temporary blip on the radar screen instead of being a game-changer.

Figure 1 – COMEX Gold Futures

Looking at the above gold chart, I marked the November consolidation with a blue rectangle, and I copied it to the current situation, based on the end of the huge daily downswing. Gold moved briefly below it in recent days, after which it rallied back up, and right now it’s very close to the upper right corner of the rectangle.

This means that the current situation remains very similar to what we saw back in November, right before another slide started – and this second slide was bigger than the first one. Consequently, there’s a good reason for gold to reverse any day (or hour) now.

Besides, there’s also a declining resistance line just around the corner.

And that’s not even the most important thing. The most important thing is that based on the similarity to how things developed between 2011 and 2013, gold’s downward trajectory is likely to have periodic corrections at this time – up to a point where it simply plunges.

Figure 2 - GOLD Continuous Contract (EOD)

When the current situation is compared to what we saw about a decade ago, it shows what one should expect, assuming that the history repeats itself.

Gold kept on declining with corrections along the way until April. In April, the decline accelerated profoundly. The biggest problem with the latter was that practically nobody expected this kind of volatility. Those who were thinking that it’s just another move lower that will be reversed were very surprised.

Right now, you know in advance that a bigger move lower is likely just around the corner, and you won’t be surprised when it comes. Whether we have to wait an additional few days or first see gold rally by $10 or $30 is not that important, if it’s about to slide $150 and then another $200 or so.

I would like to add that gold is declining today and based on the similarity to the November consolidation, it’s exactly the day when we should expect to see a decline. Of course, the similarity doesn’t have to persist, and the history doesn’t have to repeat itself to the letter, but what’s happening right now seems to be confirming the analogy in a considerable way. This means that more declines are likely just around the corner. If not immediately, then shortly.

Figure 3 - COMEX Silver Futures

Silver turned south after reaching (approximately) the price level that stopped the rally in July and November 2020, and also earlier this year. This seems relatively natural and the outlook for silver remains bearish for the next several weeks.

Silver corrected a bit more of this year’s downswing than gold, which is normal given the bearish outlook. The same goes for miners’ underperformance. Let’s keep in mind that silver’s “strength” is temporary – once the decline really starts, and it moves to its final part, silver is likely to catch up big time.

Figure 4 - VanEck Vectors Gold Miners ETF

As far as the miners are concerned, mining stocks didn’t correct half of their 2021 decline. They didn’t invalidate the breakdown below the rising support line, either. In fact, the GDX ETF closed yesterday’s session below the 50-day moving average. Technically, nothing changed yesterday.

Please note that the November – today consolidation is quite similar to the consolidation that we saw between April and June (see Figure 4 - green rectangles). Both shoulders of the head-and-shoulder formation can be identical, but they don’t have to be, so it’s not that the current consolidation has to end at the right border of the current rectangle. However, the fact that the price is already close to this right border tells us that it would be very normal for the consolidation to end any day now – most likely before the end of January.

If we see a rally to $37, or even $38, it won’t change much – the outlook will remain intact anyway and the right shoulder of the potential head-and-shoulders formation will remain similar to the left shoulder.

However, does the GDX have to first rally to $37 or $38 to decline? Absolutely not. It could turn south right away, thus surprising most market participants.

Figure 5 – USD Index

In Tuesday’s (Jan. 19) analysis, I commented on the above USD Index chart in the following way:

The USD Index is after a major breakout above the declining resistance lines and this breakout was confirmed. Consequently, the USD Index is likely to rally, but is it likely to rally shortly? The answer to this question is being clarified at the moment of writing these words, because the USD Index moved back to its rising short-term support line that’s based on the 2021 bottoms.

If the USD Index breaks below it, traders will view the 2021 rally as a zigzag corrective pattern and will probably sell the U.S. currency, causing it to decline, perhaps to the mid-January low or even triggering a re-test of the 2021 low.

If the USD Index performs well at this time and rallies back up after touching the support line, and then moves to new yearly highs, it will be then that traders realize that it was definitely not just a zigzag correction, but actually the major bottom. In the previous scenario, they would also realize that, but later, after an additional short-term decline.

It’s now clear that the former scenario is being realized. The support levels that could trigger the USD’s reversal are based on the potential inverse head-and-shoulders pattern – the red line that’s slightly above 90, and the horizontal line that’s slightly below it. It’s also possible that the USD Index tests it yearly lows. None of the above would be likely to change the outlook for the precious metals sector, at least not beyond the immediate term.

Later yesterday (Jan. 21) and also in today’s overnight trading, the USD Index moved to the upper of the above-mentioned support lines. Is the bottom already in? This seems likely, but it’s not crystal-clear yet. However, it doesn’t really matter, because the precious metals market responded to the USD’s strength for just one day (in a meaningful way that is) and taking a closer look at that day reveals that it was not the USDX’s performance that gold reacted to, but to the underlying news – the inauguration-day-based uncertainty. So, even if the USD Index declines some more here before soaring, gold doesn’t have to move significantly higher. In fact, it would be unlikely to do so.

Stocks have rallied, and based on this rally, the weekly RSI moved close to 70 once again.

Figure 6 – S&P 500 Index

This is important because the last two major declines were preceded by this very signal. We saw the double-top in the RSI at about 70, exactly when the stock market started its big declines, and we’re seeing the same thing right now. If this was the only thing pointing to much lower stock values on the horizon, I would say that the situation is not so critical, but that’s not the only thing – far from it. Before moving to these non-technical details, let’s recall why the stock market analysis and the USD index analysis matters for precious metals investors and traders.

The analyses matter because gold, silver, and mining stocks are likely to decline in parallel with a decline in stocks and the USD’s rally. This is likely to take place up to a certain point, when precious metals show strength and refuse to decline further despite the stock market continuing to fall and the USDX continuing to rally. This kind of performance happened many times, including in the first half of last year.

Since the S&P 500 futures are down in today’s overnight trading, perhaps we have indeed seen a top. Even if not, it doesn’t seem that one is very far away, based on how excessive the situation looks from the fundamental point of view. Let’s discuss some of those non-technical issues.

Mind Over Matter

Despite Janet Yellen’s recent assertion that “the United States does not seek a weaker currency,” her tongue-in-cheek comments are actually doing just that. The newly minted U.S. Treasury secretary urged lawmakers to “act big” with regard to prospective stimulus, saying that the benefits “far outweigh the costs.”

And since her worst-kept secret became public on Jan. 18, the USD Index has been under fire ever since. Furthermore, as her words instill the EUR/USD with borrowed confidence, the precious metals are displaying the same bold behavior.

Please see below:

Figure 7

However, despite the narrative overpowering reality, the Eurozone fundamentals don’t support the recent rally. And why is this important? Because as you can see from the chart above, as goes the EUR/USD, so go the PMs.

Yesterday, European Central Bank (ECB) President Christine Lagarde revealed that the Eurozone economy likely shrank in the fourth quarter – all but sealing a double-dip recession.

Please see below:

Figure 8 – (Source: Bloomberg/ Holger Zschaepitz)

In contrast, the Federal Reserve Bank of Atlanta’s GDPNow forecasting model (as of Jan. 21) has the U.S. economy expanding by 7.5% in Q4. Furthermore, even if we take the Atlanta Fed’s estimate with a grain of salt, the Blue Chip consensus (forecasts made by private-sector economists) is for growth of nearly 4.0% (tallied as of early January). And even more telling, economists with a bottom 10% Q4 GDP forecast (see Figure 9 - the shaded light blue area below) still expect positive growth.

Figure 9

The bottom line?

We can now add the Eurozone GDP to the long list of relative underperformances.

Expanding on the above, European consumer confidence (released yesterday) went backwards again in January and is now less than 10 points above its April low. Furthermore, the current reading is still well-below the long-term average.

Figure 10

On Jan. 8, I highlighted the significant divergence between European CPI and U.S. CPI (inflation). For context, European CPI was – 0.30% in December (negative for five-straight months), while U.S. CPI was 0.40% in December (positive for seven-straight months).

I wrote:

Weak CPI is a precursor to a weaker euro. Why so? Because since asset purchases fail to produce any real economic growth, the ECB will be forced to lower interest rates to stimulate the economy. As a result, the cocktail of paltry economic activity and lower bond yields leads to capital outflows as foreign (and domestic) investors reallocate money to other geographies (like the U.S.). Thus, capital will likely exit the Eurozone and lead to a lower EUR/USD.

And today?

Well, it’s exactly what the ECB is doing.

Due to the economic malaise confronting Europe, the ECB is targeting its bond-buying activity toward financially weaker counties (like Italy) as opposed to financially stronger countries (like Germany). Essentially, it’s conducting a shadow operation of yield curve control (YCC).

Please see below:

Figure 11

If you analyze the red box above, you can see that Europe’s weighted-average bond yield has increased in 2021. And why is this happening? Because as Europe’s economic deterioration merges with Italy’s fiscal plight, this cocktail has made European bonds riskier, and thus, investors demand a higher interest rate. And while higher interest rates are bullish for a country’s currency when they’re a function of economic growth, a crisis-like spike in yields (due to solvency concerns) means the exact opposite.

Furthermore, if you follow the gray bars at the bottom-half of the chart, the ECB actually decreased its bond purchases toward the end of December (2020), Then, once January hit (2021), it was back to business as usual.

As a result, the ECB’s attempt to scale back its asset purchases was (and will be) short-lived. And as the economic conditions worsen, the money printer will be working overtime for the foreseeable future.

To that point, Bloomberg Economics expects the ECB to purchase €15 billion worth of bonds per week until 2022 – more than doubling its pandemic emergency purchase program (PEPP) to nearly €1.85 trillion.

Please see below:

Figure 12

And in real-time?

Well, the ECB’s balance sheet hit another record-high on Friday (Jan. 15) – with total holdings still at 69% of Eurozone GDP (nearly double the U.S. Fed’s 35%).

Figure 13

And why does all of this matter?

Because, as I highlighted on Jan. 12, the ECB’s relative outprinting is a precursor to a lower EUR/USD.

Figure 14

I wrote:

Turning to the second chart (Figure 6 - on the right), notice how the EUR/USD tracks the FED/ECB ratio? To explain, the ratio (the light blue line) is calculated by dividing the U.S. Federal Reserve’s (FED) balance sheet by the European Central Bank’s (ECB) balance sheet. Essentially, its direction tells you which monetary authority is printing more money. If you analyze the EUR/USD (the dark blue line), it trades higher when the FED is out-printing the ECB (the light blue line is rising) and trades lower when the ECB is out-printing the FED (the light blue line is falling). The key takeaway? With the light blue line falling, it means that the ECB is outprinting the FED. And if this dynamic continues, the EUR/USD (the dark blue line) should move lower as well.

The top in the FED/ECB total assets ratio preceded the slide in the EUR/USD less than a decade ago and it seems to be preceding the next slide as well. If the USD Index was to repeat its 2014-2015 rally from the recent lows, it would rally to 114. This level is much more realistic than most market participants would agree on.

In conclusion, the EUR/USD’s recent strength is built on a foundation of sand. Instead of following the hard data, traders are letting the narrative cloud their judgment. Moreover, due to their strong correlation with the EUR/USD, gold and silver are falling into the same trap. However, once the semblance of strength evaporates, a decline in the EUR/USD is likely to usher a move lower for the PMs. Furthermore, with gold already approaching the upper trendline of its November consolidation channel, the momentum may wane sooner rather than later.

Thank you for reading our free analysis today. Please note that the above is just a small fraction of the full analyses that our subscribers enjoy on a regular basis. They include multiple premium details such as the interim targets for gold and mining stocks that could be reached in the next few weeks. We invite you to subscribe now and read today’s issue right away.

Sincerely,
Przemyslaw Radomski, CFA
Founder, Editor-in-chief

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