Commodity Trade Mantra

Gold Bugs on Watch for Buy Signal & How Gold Prices React to Fed’s Rate Hike

Gold Bugs on Watch for Buy Signal & How Gold Prices React to Fed's Rate Hike

What is it that the Gold Bugs want to hear?

Mark Hulbert: Sentiment conditions in the gold market have improved markedly over the last three weeks.

What’s required for contrarian-minded investors to trigger a “buy” signal is for even more gold timers to throw in the towel. A good number have already, which is why contrarians are beginning to take notice of gold GCJ7, +0.03%  .

Consider the average recommended gold market exposure level among several dozen short-term gold timers that I monitor on a daily basis (as measured by the Hulbert Gold Newsletter Sentiment Index, or HGNSI). This average currently stands at minus 14.7%, which means that short-term gold timers on average are allocating about a seventh of their gold portfolios to going short.

To put that in context, as recently as Feb. 23 the HGNSI stood at +41.3%. So in less than three weeks’ time, the average gold timer has reduced his recommended exposure level by 56 percentage points. Contrarians find it encouraging whenever bullishness plummets so much in such a short period of time.

Why then have contrarians not yet issued a gold buy signal? The answer is evident from the above chart: The HGNSI’s cycle lows in recent years have occurred at even lower levels—below minus 30%, in fact.

So even though we are a lot closer to a contrarian buy signal than we were a couple of weeks ago, we’re not there yet. Don’t jump the gun, and instead just wait for the markets to tell their story. If more and more gold timers throw in the towel in coming days, then you can start holding your breath for a contrarian buy signal.

Some eager-beaver gold investors have contacted me recently to inquire about another gold sentiment indicator, which is based on the relative performance of gold-mining shares and bullion itself. Though not all followers interpret this indicator in the same way, many believe that gold-mining stocks are more susceptible to investor sentiment than the metal itself.

I’m not convinced that gold mining shares’ relative strength tells you anything. At least that’s what I concluded upon plugging into my PC’s statistical package a decade’s worth of data for bullion and gold shares. I found that gold mining stocks’ relative strength was unable to forecast gold’s near-term movements, regardless of whether I was measuring relative strength or subsequent performance over a month, a quarter, or a six-month period.

Which brings me back to my original conclusion: Close as we may be getting to a contrarian-based gold buy signal, we’re not there yet.

What Drives the Price of Gold?

– Frank Holmes: In my more than 35 years of investing in hard assets, precious metals and mining, I’ve learned to manage my expectations of gold’s short-term price action. Sure, there have been surprises along the way, but generally, the yellow metal has behaved relatively predictably to two macro drivers, the Fear Trade and Love Trade.

Last year, gold had its best first half of the year in decades, all in response to Fear Trade factors such as low to negative global government bonds and geopolitical risks, specifically Brexit and the upcoming U.S. election.

But the Love Trade failed to lift gold in the fourth quarter mainly because Indian Prime Minister Narendra Modi’s demonetization efforts to combat dark money and tax evasion left many low and middle-income Indians without the cash to purchase gold jewelry for weddings and investment purposes.

Investing, like life, is all about managing expectations. But if you don’t know what to look for, this can be difficult to do. That’s why we put together this video to help educate investors like you on what we believe are the top five drivers of gold. I hope you find it helpful in informing your investment decisions. If you find any value in it, I invite you to pass it along to your friends and colleagues.

How Will Gold Prices React to the Next Rate Hike?

– Frank Holmes

Strengths

  • The best performing precious metal for the week was gold, down 2.43 percent, but still leading its precious metals peers. Gold imports by India are said to have risen nearly three-fold in February from a year earlier, reports Bloomberg, jumping 175 percent. Jewelers are restocking for the upcoming festival and wedding period that starts next month.
  • The U.S. saw its largest trade deficit since March of 2012, reports Bloomberg, as a jump in merchandise imports in January exceeded a smaller gain in shipments overseas. “The wider deficit indicates trade, which subtracted 1.7 percent from fourth-quarter growth, will weigh on the economy in early 2017,” the article continues.  A stronger dollar has made exports less competitive and could be hindrance to boosting manufacturing jobs in the U.S. as President Trump promised.
  • Joni Teves, strategist at UBS, writes that the research group expects underlying positive sentiment toward gold to remain broadly intact as uncertainty lingers. In its Global Precious Metals Comment, Teves outlines that despite the recent increase in positioning, gold market length remains relatively subdued with net positions in Comex accounting for about 50 percent of the record. Similarly, UBS writes “there really isn’t much expectation of an aggressive selloff in gold – this has been a common theme among our conversations with market participants in different regions.”

Weaknesses

  • The worst performing precious metal for the week was platinum, down 5.72 percent.  Silver was not far behind with a loss of 5.22 percent.
  • According to a weekly Bloomberg survey, nearly half of gold traders and analysts are bearish on gold as the dollar strengthens amid expectations of a Fed rate hike next week. Overseas, the People’s Bank of China reports gold holdings unchanged for a fourth-straight month, coming in at 59.24 million ounces by the end of February. Similarly, Bullionvault’s Gold Investor Index, which measures the balance of client buyers against sellers, fell to the lowest level since July.
  • Gold fell below $1,200 an ounce this week, the longest losing streak since October, on better-than-expected U.S. private jobs data – adding to positive economic talk that boosted the dollar. “Three weeks ago the possibility of a rate hike in March was very small, but now it’s 100 percent,” said Bob Takai, CEO and president of Sumitomo Corp. So where exactly does the Fed see rates headed? The chart below gives a quick comparison between the Fed Funds Target versus where the Taylor Rule Estimate, estimating close to 4 percent.  The sudden shift to raise rates in March may reflect that the Fed is behind the curve again.

Opportunities

  • Hedge funds are bracing themselves for tough times ahead this year, reports Bloomberg. Managers have stopped loading up on bullish positioning, becoming less reliant on U.S. stocks and selling economically sensitive bank shares and materials like copper, the article continues. Now they are buying gold. Quants from UBS and Goldman Sachs are also seeing opportunity for the yellow metal, using different modeling techniques they conclude that the dollar is perhaps 30 percent overvalued. And despite gold being under pressure leading up to the next rate hike, Bank of America still sees prices rallying by around $200 by the end of the year.
  • Mike McGlone, a BI Commodity Strategist, writes this week that commodities often prevail in tightening cycles, perhaps now more than ever. For example, bullion gained 52 percent in the June 2004 to June 2006 tightening cycle and 5 percent from the June 1999 to May 2000 tightening cycle. “The Fed is only tightening when they are concerned about inflation,” McGlone said. “That is good for gold.” In fact, the yellow metal bottomed a day after the past two tightenings and rallied thereafter.
  • After four years of restraint, Bloomberg reports that mining investment bankers say deal-making is starting to flow again. Paul Knight of Barclays Plc says this is the busiest it’s been in his four years with the company. “If our experience here is any indication of what’s happening around the street, you may well see more M&A activity at the end of this year than we’ve seen in the last three or four years,” Knight commented. China Gold, the nation’s largest government-owned gold producer is even back on the acquisition hunt after bulking up mines, reports Bloomberg.

Threats

  • Morgan Stanley points out that a revised draft of South Africa’s mining charter could still contain very disadvantageous requirements for mining companies that are not reflected in the share prices. One of the key concerns around the potential draft includes the fact that the once empowered, always empowered rule no longer applies and companies have to empower back to 26 percent if they are below the threshold.
  • Steven Mnuchin’s picks for the top ranks of the U.S. Treasury are being stalled due to resistance from the White House, reports Bloomberg. More specifically, questions about loyalty to Trump have played a role in at least two cases – including one recruit whose Twitter account was scrutinized for potential criticism of the president. On the flip side, David Nason, who is a leading candidate to be named the Fed’s bank supervision chief, told the White House he is no longer interested in the job. Nason plans to pursue opportunities at GE instead.  And if you thought Russian hacking in the U.S. has pulled back since the election, you would be wrong.  Liberal think tanks, critical of President Trump,  around the U.S. are finding that their firewalls have been breached by Cozy Bear and they are being asked to pay ransoms in bitcoin to prevent sensitive data from potentially being leaked.
  • According to a study by consultant Roland Berger GmbH, the proposed U.S. border tax would make most automakers unprofitable, reports Bloomberg, along with strain consumers and lead to job losses rather than gains. “The planned charge would increase the average cost of a car by $3,300, prompting a drop in demand and forcing manufacturers to react by shrinking their U.S. workforce,” the firm said in a presentation on Wednesday.

 

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