Gold Price Forecast: It Could Be Rosy, But…

The entire precious metals market moved sharply lower yesterday. Silver erased more than it had gained on Wednesday and mining stocks broke below their rising support line. All this happened while gold closed below $1,420 for the first time this week and after it had formed yet another weekly reversal. Can the precious metals continue to rally regardless of all the above? They can, but…

…They are very unlikely to. The above combination of factors is already very powerful, but it’s additionally strengthened by other trading factors, i.a. the breakout above the inverse head-and-shoulders formation in the USD Index and the downtrend in the gold stocks to gold ratio.

Let’s take a closer look for details, starting with the outlook for the USD Index.

The USD Index Digests Recent Gains

We previously commented on the USD Index by describing the possible (!) implications of the potential (!) pattern that might have been forming. Until a given pattern is completed, it has practically no direct implications. If it was any other way, a partial pattern would itself become a pattern (a.k.a. formation) with its own name and implications.

What we saw on Tuesday was a decisive breakout above the neck level of the inverse head-and-shoulders pattern, which means that the short-term outlook for the USD Index just improved in a major way. The rally that follows this kind of formation is likely to be at least as big as the size of the head. We marked it with the vertical, dashed line. Yes, it implies a move well above the previous 2019 high.

Initially, it seemed that the precious metals investors were not "buying it" yet. The dollar failed to break to new highs many times, so many people were assuming that it will fail once again. However, the inverse H&S pattern tells us that this time it's actually going to soar through the previous highs. This will likely be a big surprise for the PM investors and when people are surprised, they act quickly. This time, the reaction will likely be driven by fear, which will probably make it particularly volatile.

Gold moved higher recently, but it failed to rally above the late-2013 high - it invalidated the initial breakout. Invalidations of breakouts are usually followed by sizable declines, and the current situation in the USD Index perfectly fits this scenario for gold.

The USD Index just confirmed its breakout by closing above the neck level for third consecutive day and all the implications described above are even stronger. The noteworthy thing is the precious metals’ reaction to the USD breakout. We wrote that the investors were not “buying it”, but it seems that has started to change yesterday. The USD was up rather insignificantly (just 0.10), while gold declined in a more visible way (almost $10).

PMs Reflect the USD Index Breakout

While gold declined, silver declined more, and mining stocks closed at the week’s lowest level. This is not very significant by itself, but the breakdown below the rising support line is. The line is based on the intraday lows and the breakdown was confirmed by the closing price. If the line was drawn using the closing prices, the breakdown would be much clearer. Either way, it will need to be confirmed for the implications to become stronger. The odds are that it will be confirmed shortly i.a. due to the USD Index outlook.

Speaking of gold mining companies, let’s check how they performed relative to gold. We’re going to use the HUI as a mining stock index due to its popularity, wide data availability and the fact that it focuses practically solely on gold miners.

Miners to Gold Ratio Still in a Downtrend

The HUI ratio to gold soared in the last couple of weeks, but it generally remains within the broader downtrend. The ratio is just a little above the low that it reached in 2000 and significantly below the 2008 low. The downtrend that started in 2004 remains intact up to this day. Naturally, gold miners usually outperform gold on a short-term basis, but since they also multiply gold’s moves on the downside, the miners don’t have to provide the bigger bang for the buck compared to the buck invested in gold itself. At least not in the long run.

Technically, we see that the ratio moved just a little above the declining resistance line that’s based on the 2011 and 2016 highs. This breakout would need a confirmation in order to be really bullish and given all that we wrote above, it seems very unlikely that it will be confirmed. What is likely, is that this tiny breakout will be invalidated, and invalidations of breakouts are strong sell signs. The follow-up action is not likely to be a major rally. It’s likely to be a sizable slide, just like the one that we saw in 2011 or 2016.

Some may say that the recent rally is a bullish sign that indicates that there will be no bigger move lower. Please note that it has already happened. The sharpest slide of the past two decades took place in 2008 and this decline was preceded by a sharp rally.

What does it mean? It means that the mining stock relative valuations can get even more ridiculous than they were in late 2015 and early 2016.

Let’s get back to gold and zoom out to make sure we see the forest, not just the trees.

Broader Check On Gold

While the daily closing prices are important, the weekly closing prices and weekly price changes are even more so. We previously commented on the very bearish implications of the shooting star in gold as it was accompanied by huge volume and these indications were just confirmed by yet another analogous reversal. Last week’s reversal was also accompanied by huge volume so we clearly see that gold bulls are being overpowered here.

It's also important to keep the price level in mind. It’s the late-2013 high that gold tried to break above. Gold’s inability to hold its gains and the quick invalidation of all attempts to breach the late-2013 high serve as a strong bearish indication.

The RSI above 70 says that gold is overbought from the medium-term point of view (in terms of weeks) - and both reversals clearly confirm that the rally is over.

Summary

Summing up, the short-, medium-, and long-term indications point to lower precious metals’ prices in the following weeks and months. We know that these are not pleasant times for anyone who refuses to jump on the bullish bandwagon just because prices are moving higher, but what’s profitable is rarely the thing that feels good initially. The relative strength in the silver market is a factor that’s beyond bearish, while the previous strength in gold stocks appears just as misleading as their weakness was back in early 2016. Gold has just invalidated its breakout above the previous highs, the late-2013 highs, and the upper border of the pennant pattern, which is a very strong bearish sign. The situation in the currency market confirms the bearish outlook for the PMs. In those circumstances, we simply cannot forecast higher gold price in the medium term. There will most likely be times when gold is trading well above the 2011 highs, but they are unlikely to be seen without being preceded by a sharp drop first.

Naturally, the above is up-to-date at the moment of publishing and the situation may – and is likely to – change in the future. If you’d like to receive follow-ups to the above analysis, we invite you to sign up to our gold trading newsletter. You’ll receive our articles for free and if you don’t like them, you can unsubscribe in just a few seconds. Sign up today.

Przemyslaw Radomski, CFA

Editor-in-chief, Gold & Silver Fund Manager

Sunshine Profits - Effective Investments through Diligence and Care

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