Will the Stock Rollercoaster Trigger a Rollover in Gold?
Based on the August 12nd, 2011 Premium Update. Visit our archives for more gold & silver analysis.
This is one of those weeks where it is truly difficult to know where to begin. This is August. Nothing is supposed to happen in August. But this week gold shot up when markets plummeted, and gold shot up when markets soared. It was one of those weeks when gold could do no wrong.
Do we begin with the downgrade by Standard & Poor rating agency of the U.S. that took place only last Friday but already seems like old news? (Like Jon Stewart said, you'd think that we would not take so seriously a company whose name literally translates to Average & Below Average.) The Democrats are calling it -- the "Tea Party downgrade," hoping blame for the fiasco will stick to the Republicans. Nobel Prize winning economist Paul Krugman, writing in his weekly column in the New York Times, called the downgrade "chutzpah."
"If there's a single word that best describes the rating agency's decision to downgrade America, it's chutzpah -- traditionally defined by the example of the young man who kills his parents, then pleads for mercy because he's an orphan."
Perhaps we need to talk about the subsequent Wall Street bloodbath that took place on Monday when the Dow Jones industrial average fell 5.6 percent on the heels of a 5.75 percent drop the previous week. All this happened while President Obama was giving a televised speech to calm the markets. (It brings to mind Nero fiddling while Rome burns.) On Monday gold prices soared above the $1,700-an-ounce barrier and it was only three weeks ago when we were giddy about gold having crossed the $1,600-an-ounce barrier.
If ever there was a time in Washington for the three Rs, -- remorse, repentance and regret-- it should have been that Monday after the embarrassing downgrading of the nation's credit rating. Poll numbers showed public support for Congress at record low of 14 percent.
Then we get to Tuesday when markets rallied with the Dow Jones industrial average up almost 430 points. The interesting thing is that gold prices continued to climb hitting yet another record slicing through the $1,750 milestone. Gold's gains seem incongruous with huge market upsurge when normally gold tends to decline. However, this was after the Federal Reserve announced that it would keep interest rates low through mid-2013 in order to help the U.S. economy. Gold, which doesn't pay dividends or interest and costs money to store, becomes more attractive when interest rates are low making Treasuries less attractive. Actually, with negative real interest rates, gold becomes the only sure bet there is (except other precious metals), as bonds provide you with negative return.
However, all of Tuesday's gains were wiped out on Wednesday when at the end of trading, the Dow was down 520 points, or 4.6 percent, and the Standard & Poor's 500-stock index was off 4.4 percent. Now it was worries about European banks that caused a frigid wind to blow on both sides of the Atlantic. But again gold was unstoppable. Gold futures rose to a record gaining $45.80, or 2.7% to $1,789 an ounce, benefiting from the U.S. Federal Reserve's decision to keep ultra-low interest rates. Again, was it only three weeks ago that we were giddy about gold having passed the $1,600 mark? In our essay on the gold rally (July 22nd, 2011), we wrote the following:
Being technical analysts is one of our professions, so it is quite rarely when we feel any emotions regarding the market regardless if we're making substantial gains or if we're on the losing side. But, off the record, we will admit to a slight twinge of a thrill when gold broke the psychological barrier of $1,600 an ounce (...).
And here we are, three weeks later with gold having nicked the $1,800 mark? Pinch us.
With so much going on in the precious metals market, we hope that the rest of August will prove to be calm. We will now take you to this week's technical part. We will start with analysis of the S&P 500 Index (charts courtesy by http://stockcharts.com.)
In the long-term SPX S&P 500 Index chart, we see that this week's move in stock prices has been quite profound and certainly the biggest decline of the current year. It was indeed significant and touched a few important support lines. The long-term 50% Fibonacci retracement level was touched and provided support as stocks reversed soon after reaching this level. The quick reversal created a weekly candlestick pattern, which looks like a bullish-hammer reversal pattern. This was also accompanied by strong volume and confirms the bullishness of the candlestick. Naturally, the week did not end yet, but the odds are that the pattern will hold.
In the medium-term S&P 500 Index chart this week, we see that the 38.2% Fibonacci retracement level, based on the 2009-2011 rallies was touched. This coincided with our target based on the 200-week moving average. At this point, the situation looks quite favorable for stocks.
Although, the general analysis of sentiment across the financial news portals has recently been scary and somewhat pessimistic, the pundits declare, often in the same breath, that Warren Buffet is buying. So given the latter, is it more likely we are at a local top or local bottom? Surely Mr. Buffet buys low, not high and it therefore seems obvious that we are close to or at a local bottom. The situation appears similar to what was seen last year (April-May) when stocks declined, moved back and forth a bit and then moved slightly lower before bottoming and beginning a significant five to six month rally.
In this week's Correlation Matrix, we see that gold and the general stock market have a significant negative correlation in both the 30-day and 90-day columns. Therefore, if stocks rally, gold prices are likely to decline. Based on this and the bullish sentiment discussed previously for stocks, lower gold prices appear more likely than not for the near term.
Looking at gold from the perspective of the Japanese yen we have an extremely overbought situation based on the RSI level and a long-term resistance level also in play. In this chart (as well as in other gold charts featured in the full version of this essay), a local top appears to be upon us. It is important to note that when multiple perspectives and tools all point to the same general outlook, it greatly increases the odds of the outlook being right on.
On a side note, the reason that we feature the Japanese yen separately is that gold viewed from this perspective is particularly different than from other non-USD perspectives.
Summing up, the situation for stocks in general looks bullish in the short term. With the general stock market having significant negative correlation with gold, this implies lower prices of the yellow metal and analysis of gold itself confirms that. Based on the points made above, it does appear that we are quite close to a local top and long positions in gold at this point seem very risky, at least for the short term.
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Thank you for reading. Have a great and profitable week!