Gold Price Attempts Breakout…Yet Caution Warranted

Saturday, July 29, 2017

fine gold

Since gold’s all-time high of $1,923 per ounce in September 2011, the nearly 6-year decline that this week has brought prices back to $1,270 has been broadly defined by a falling linear trend of selling pressure. This declining trend is being tested immediately, and a breakout higher would be a major signal that gold’s period of falling prices has come to an end. However, caution is warranted as leading indicators are still flashing warning signals for precious metals prices.

We are, of course, referring here to technical analysis of the gold market. Technical analysis is the study of observable trends in price data. If we align ourselves with the primary underlying trends that are at work in the market, we can increase the probability of success and reduce the risk that the market moves opposite to our expectations over a prolonged period of time.

For example, many fundamental-based analysts who in 2011, 2012, 2013, and 2014 properly understood that world central banks would continue to debase their currencies through inflation, negative interest rates, and unsustainable debt loads, nonetheless failed to observe that gold had entered a clear counter-cyclical downtrend during this time. Even while those fundamentals remained true, gold began to fall in 2011, breaking down through $1,800, $1,500, and even below $1,100 on the way to 2015’s bottom. No matter the apparent fundamentals, sellers dominated during this period, and those who ignored the observable trend in selling did so to their own financial detriment.

The downtrend in sellers is plain to see on the chart below by the lower peaks that correspond with the magenta-colored line, labeled “2011 – 2017 Downtrend”:

With gold’s advance this week to $1,270, we count this as no less than the 7th attempt by the gold market since mid-2016 to negate this declining trend of sellers.

The Trend Is Your Friend

Technical trendlines are important to monitor because they illustrate the underlying pulse of the market. It is no coincidence that one of the most famous of investment adages is: “The trend is your friend.”

Why are trends important?

Because without aligning ourselves with a clearly-established trend, our investment dollars may stagnate at best – if not decline significantly – as has been the case with gold since 2011.

A Gold Trend Reversal?

At this week’s close just below $1,270 per ounce, gold is once again attempting to break out of this long-term declining trend.

When this break finally occurs, it will be a key signal for investors to note, as it will shift the odds of further price declines much lower. On a major downtrend break, typically prices will begin basing in a sideways manner for a period, before a new rising trend will emerge.

Further, a number of technical-based traders who have all been waiting for this same signal will be using the trendline break to begin purchasing gold. These traders have been waiting on the sidelines for years… waiting to see a clear shift in the underlying direction of the precious metals markets. The long-term downtrend break is one of those signals they are waiting for… and when a flux of new buyers all enter the market on the same signal, a rapid initial price surge is often the result.

And indeed, our calculated target for gold’s price is exactly $1,535 within 12 months of a successful downtrend break as is now being attempted. In sum, the pending move should not be small, when it finally occurs.

Warning Signal From The Mining Complex

In technical analysis, there are several important tools which can give us hints as to the legitimacy of a pending price move. Examples include relative strength, moving averages, and gold compared to other commodities. Yet one of the most important comparisons we can make is to examine gold versus the values of the companies that dig this precious metal out of the ground: that is, gold compared to the gold miners.

There should be some observable relationship between gold and the gold miners. After all, the miners’ profits are leveraged to the price of the metal itself. Due to relatively high fixed input costs, a 10% increase in the price of gold can easily translate into a 20% - 30% increase in the profits for a large gold miner.

Investors in gold miners know about this leverage effect, and therefore the share prices of the miners often serve as a discounting mechanism for the future gold price. That is to say, investors will either bid up or sell off shares in gold miners prior to a change in the price of the metal itself. In this way, the value of gold miners will typically lead the price of gold at major crossroads.

Miners Declining Amidst Gold Strength

Unfortunately, when we examine the relative price action of both the senior large-cap gold miners and gold since the beginning of the year, we see a clear negative divergence. Below we show the GDX gold miners fund on top, with the price of gold immediately below, since January 1, 2017:

Note how the GDX gold miners peaked in February just below 26 on the index. This corresponded with gold’s price of $1,265 a few days later.

However, gold’s next peak in April at $1,295 was not met with a higher level in the GDX. In fact, the GDX only rose to 25 in April. This is a negative divergence between the miners and the metal.

This negative divergence has continued through gold’s close on Friday. The miners continue to make lower peaks amidst gold’s rising trend since the beginning of the year. What are the miners signaling?

When we examine this phenomenon throughout the history of gold since the year 2000, in most instances when the gold miners move in the opposite direction from their own primary product – gold – they are foreshadowing weakness to come in the metal price itself. While no signal is 100% perfect in technical analysis, and there are rare occasions in which the miners are “fooled” and end up following the gold price higher in time, over the vast majority of cases when the miners fail to reflect gold’s advances they are doing so in anticipation of lower gold prices to arrive.

The fact that we are observing this negative divergence at exactly the time of a critical long-term breakout attempt (see first chart) adds even more weight to the signal.

The miners do not believe gold itself will sustain its advance right here and now.

Who Will Be Right?

Are the miners correct in their negative divergence signal, or will gold drag the producers higher “kicking and screaming” to use the colloquial phrase?

We cannot know for certain; however, in the majority of cases throughout history the miners prove correct.

How one chooses to include this data point into one’s investment outlook is dependent on the individual. For example, those on a physical gold accumulation plan may want to simply delay their next purchase, should the possibility of lower prices below $1,200 arise. However, those over leveraged in the mining sector, triple ETF’s, futures, or options may consider de-leveraging into this gold strength.

Takeaway On Gold

Gold remains perched at a critical juncture, attempting to negate a 6-year declining trend in prices. Thus far in 2017 gold has risen in a series of peaks. However, the companies which mine for gold have seen declining valuations throughout 2017 compared to the metal itself. Investors should use caution as this signal may hint at a gold decline through the second half of the year.


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Christopher Aaron

Christopher Aaron began his career as an intelligence analyst for the CIA and Department of Defense. He served two tours to Afghanistan and Iraq between 2006 - 2009, conducting pattern-of-life mapping for military leaders.

Mapping shares similarities with technical analysis of the financial markets because both involve the interpretation of repeating patterns found in human nature. He is the founder of iGold Advisor, providing research on the precious metals, and iGlobal Analytics, featuring technical analysis of the global capital markets.

Christopher speaks regularly on the cyclical patterns found within the financial markets and on international policy. He has been featured in the New York Times and NPR news amongst other publications.