Beware the fear card
05/25/18

Fear can make people do funny things—especially trader people.

To wit, there’s plenty of evidence that gold isn’t a very effective inflation hedge (see “Market menace or trade opportunity?”), but that hasn’t prevented the yellow metal from becoming an increasingly hot trading topic in these days of rising interest rates and increasing (but still very moderate) inflation. And traders still may rush into gold whenever the world seems like a dangerous or uncertain place.

But although gold may often pop whenever geopolitical tensions reach a fever pitch or surprises jolt the market, those jumps can often be as fleeting as the news stories that drive them—even when gold is in a longer-term uptrend. Right now, it’s not, although yesterday’s rally may have given gold bugs hope that 2018’s sluggishness may be ending.

Yesterday’s equity market downturn was attributed in many circles to the White House’s announcement that it was pulling the plug on the June US-North Korea summit—a day after the administration backed away from a China trade deal and threatened tariffs on imported cars. And gold responded the way many people would expect it to. While the Dow Jones Industrial Average (DJIA) dropped more than 1% intraday, the following chart shows June gold futures (GCM8) rallied a similar amount—their biggest up day in more than a month:

June gold futures (GCM8), 12/6/17 – 5/24/18. Gold daily price chart.

Source: OptionsHouse


The move pushed gold out of a brief congestion that included a decline to the lowest levels of the year (around $1,281 on Monday), and recouped around two-thirds of the huge May 15 down day. A possible intermediate-term bottom before another upside run? Well

As mentioned, gold is not in a long-term uptrend, although it’s not too far from its highs of the past two years. (The market took three or four shots at the September 2017 high of $1373.60 before the current downswing began in mid-April.) The following weekly chart shows the May 15 wide-range down day represented a definitive breakdown below a support level that had remained intact (on a closing basis) since early this year:

June gold futures (GCM8), 12/6/17 – 5/24/18. Gold daily price chart.

Source: OptionsHouse


From this longer-term perspective, an argument could be made that gold has had a downside bias since its January peak and, having broken support, could challenge its late-2017 lows around $1250.

The caveat, of course, is that the world doesn’t truly go to hell in a handbasket and trigger a fear-driven run on gold (the perennial hope of gold bugs). But here’s where some basic price action principles (mentioned once or twice in this space, ahem) may come in handy in deciphering gold’s possible trajectory.

First, prices can often return to test a breakout/breakdown level before continuing in the direction of the breakout. Yesterday’s rally pushed gold back to the breakdown level smashed by the May 15 wide-range down day—a run-of-the-mill example of this principle. It would cease being so if prices definitively rallied above the May 11 swing high (the upper boundary of the May consolidation, around $1326). That’s when gold bulls may feel a bit bolder.

The whipsaws the market has experienced in recent months amid the seemingly day-to-day changes in the US-China, US-North Korea, and US-Iran relationships are a testament to how briefly both good news and bad news can dominate market sentiment.

Yesterday seemed like a bad day, from that perspective. Tomorrow could be a completely different story.

Market holiday reminder: US stock exchanges will be closed on Monday for the Memorial Day holiday while some US futures contracts will have truncated trading sessions. For a look at the stock market’s tendencies after Memorial Day, check out “Below the radar bullishness.”

 

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