For the past few months, there have been some catalysts that have depressed commodity prices. The number one reason has been the rally in the dollar caused by Italian elections, Cyprus’ banking issues, strong U.S. economics, and anticipation of Japanese easing monetary policy. Looking at the charts of gold, oil, and copper we can deduce some other factors – mainly these commodities have been trading in a sideways pattern until two weeks ago when gold was raided. As technical analysts have been saying for some time, be prepared for a washout in gold. As gold, oil, and copper rallied over the past two weeks, it’s time to review these areas and determine what the charts and fundamentals are saying.
The chart of the CRB index and the U.S. dollar shows the inverse relationship between the two. Recently, we can see how strength in the dollar has weakened commodity prices. Neither the U.S. dollar nor the CRB index show a reversal in this trend – despite the recent rally in copper, oil, and gold. The CRB index has popped this week, but mainly due to an oversold condition than anything else.
Out of all of the commodities that we can trade, gold tends to be the most sensitive to changes in the dollar as they’re both very closely tied to monetary policy. As I mentioned on the radio show two weeks ago, gold fell as technical support broke when traders considered what would happen if European central banks sold off their 3,500+ metric tons of gold reserves to fund debt bailouts, like Cyprus. Stop losses triggered on gold and selling begot more selling. Gold has been rallying ever since that Friday and Monday route. Part of the reason is that while paper gold sold off, physical gold is exhibiting signs of shortages. The classical definition of a demand curve states that as the price of a commodity falls, more consumers are willing and able to purchase it.
Relate the recent drop in gold to the announcement of a hurricane in Florida or a fire in California. The equivalent of a hurricane warning hit gold investors as investors debated whether the rest of Europe would sell off its gold reserves. So investors sold their paper gold and boarded up their portfolio’s windows from an impending European-gold-reserve-hurricane-sell-off as gold broke the widely publicized support of 50.
The number one issue with the European catalyst is that it’s bogus. It wasn’t stated that European central banks “will” sell off reserves, but that they “could”. Cyprus sold 10 metric tons of its central bank gold and now every central bank would do the same? The Swiss have actually done the opposite of the Reuters article two weeks ago. This week they announced the “Save our Swiss Gold” measure to increase their current 10% reserves in gold to 20% and ban sales below that level (FT article).
The gap between paper gold supply and physical demand couldn’t be any wider. Jim Puplava called two of his personal vendors last week to purchase silver eagles and they were out. I called our bullion trading desk last week and of the two vendors National Financial had relationships with, one was running low and would settle trades five days later instead of two. The world’s largest jeweler by market cap, Chow Tai Fook (Hong Kong), said some of its stores were sold out of gold bars (Yahoo article). Two days ago, Reuters reported that the U.S. mint was on track to challenge the American Eagle volume record sold in December of 2009 near 231,500 ounces (Reuters article).
Now, while I solemnly believe that this was a buying opportunity, I’m not so sure that we’re headed back towards 00 until conditions change regarding the U.S. dollar. The best returns that I’ve seen over the last eleven years, for gold, have been when the U.S. dollar was falling – the same goes for commodities. Commodities and gold specifically are still in a long-term downtrend. So even though gold and silver investors capitulated out of their paper and precious metal stocks last week, the rally is in the context of an oversold bounce within a negative long-term trend. The close for gold above 25 was key towards improving the short to intermediate-term trend and it’s likely we will retest the 00-50 resistance zone (old support) on this snap-back rally; however, more is needed to improve the long-term trend for gold.
The dollar next week faces a possible bullish catalyst in the ECB meeting. It has been widely debated in the financial community that the ECB needs to cut rates by .25 to 0.50%. There’s also been a large amount of discussion that the transmission mechanism is broken while banks continue to pay back LTRO, shrinking the ECB’s balance sheet. It’s been estimated that the ECB should introduce a new LTRO or a new easing policy to help stimulate credit expansion. If the ECB weakens the euro through the use of one of these policy tools, it would likely strength the dollar; however, our own Federal Reserve Bank announces its policy next week. If they announce a larger QE program, that may weaken the dollar, but I don’t think two months of slower growth will be enough to launch a new program as of yet. Additionally, the Dollar/Yen continues to press on 100. Watch for a breakout or reversal for signs of strength or weakness in the dollar, respectively; however, thus far the trend continues to be for a stronger dollar/yen.
Risk On
A shift in asset performance has happened this week in risk assets which I’ll explain in more detail on the Saturday FSN market wrap up. Ever since Caterpillar’s rally on Monday despite a disappointing quarter while safe-haven stocks have come under sale (the likes of Proctor & Gamble, AT&T, Heineken, and Amgen), a rotation may be developing. The only question now is whether it has legs. It will be something that is in need of tracking over the next week or two.
Conclusion
Gold is rallying off a deeply oversold bombing in price two weeks back. Recent shortages in physical are encouraging bold investors to dive into gold. The fact that gold is rallying in v-spike fashion is a bullish reaction to low prices. We’ve seen gold v-spike many times before which shows that there’s ample demand when sellers get too aggressive. Questions remain whether the bounce in commodities and other risk-on investments is a true long-term reversal or just an oversold bounce. It’s encouraging that all of the risk-on assets are rising in unison, but it has only been two weeks in the context of gold that has fallen since October and commodities (as a whole) that have fallen since the April 2011 highs. The v-spike in gold, however, proves that investors are willing to catch a falling knife, if it’s made of gold.
