Gold Technicals Wound Up

Gold spent the better part of 2021 consolidating sideways, which eroded most bullish sentiment.  With little upside momentum to chase, investors largely abandoned this leading alternative asset.  And gold-futures speculators freaked out and fled multiple times on Fed-tightening fears.  While all that left gold in the doghouse, this metal’s technicals are wound tight in a gigantic bullish pattern implying big gains coming.

To successfully game where markets are likely heading, you have to first understand where they have been and why.  Trending price action is a causal chain, where events A, B, and C directly lead to D.  My essays over the last couple weeks provided that essential context, extensively exploring and analyzing what has happened in gold over this past half-year.  This metal’s vexing grind in that span is fully-explainable.

Periodic bouts of heavy-to-extreme gold-futures selling erupted on speculators’ fears of Fed rate hikes and slowing quantitative-easing money printing.  Those violent pukings slammed gold sharply lower, which really damaged sentiment.  That left investors increasingly apathetic, unwilling to deploy capital into the yellow metal.  Even though gold recovered between futures selloffs, upside momentum was sorely lacking.

With investors not interested enough to return while gold-futures speculators endlessly worried about Fed tightening, gold couldn’t make much headway.  That has left it deeply out of favor, as traders are a what-have-you-done-for-me-lately lot.  We humans tend to greatly overweight the present, extrapolating current conditions way out into the future.  Recently gold has looked doomed to grind sideways-to-lower indefinitely.

But the major trend shifts that earn smart contrarian traders fortunes are never apparent with a myopic short-term focus.  Much-broader perspective is necessary to see when probabilities favor key transitions from uplegs to corrections and vice versa.  Layered on top of gold’s core fundamental analysis from my last couple essays is a gigantic bullish technical pattern.  It is winding ever-tighter, portending a major breakout.

Gold felt awesome in 2020 because it blasted 25.1% higher, and bearish in 2021 because it has drooped 5.7% year-to-date.  But prevailing gold levels are actually better this year than last year, as gold averaged $1,798 so far in 2021 compared to $1,773 in 2020!  Gold has largely spent this year consolidating high, digesting its huge gains from last year.  That consolidation has formed a huge bullish pennant formation.

Visualize a flagpole off of which a triangular flag is billowing, like at a renaissance festival.  This updated gold-futures chart from last week reveals that pattern at a very-large scale.  Gold rocketed higher in two mighty 42.7% and 40.0% uplegs peaking in 2020, which is the flagpole.  All the sideways-grinding price action since gold crested at an all-time high of $2,062 in early August 2020 is the pennant.  This is one big flag!

Gold’s enormous pennant is defined by downward-sloping resistance and upward-trending support lines converging at similar angles.  That resistance zone was initially formed during gold’s healthy correction after soaring to crazy-overbought levels in summer 2020.  Then it was solidified in two subsequent upleg attempts into June 2021 and November 2021.  Gold has suffered lower highs over the past 16.5 months.

Traders’ market perceptions are always filtered through their biases.  So anyone bearish on gold, which is the vast majority today, sees these lower highs as technical evidence gold is weakening.  Why bother with it if it can’t make any material headway over such a long span?  New bull highs attract in countless new traders, and gold hasn’t achieved any of those since August 2020.  That has left this asset deeply out of favor.

Gold indeed languished in an expected correction downtrend until early March 2021.  Then it carved a major double-bottom and a solid young upleg got underway.  That 13.5% surge higher over 2.8 months was way too big and lasted much too long to be a countertrend rally within a correction.  It was the real deal, this secular gold bull’s next upleg.  Unfortunately a hawkish Fed prematurely killed it in mid-June.

Extreme gold-futures selling erupted on Fed-rate-hike fears, after top Fed officials’ individual outlooks on future federal-funds rates showed maybe two quarter-point hikes way out into year-end 2023.  The resulting 5.2% gold plunge in just three trading days also slayed mounting bullish sentiment.  With gold-futures speculators selling periodically since and gold investors missing in action, gold has mostly drifted sideways.

But fascinatingly despite that vexing high consolidation sapping all enthusiasm, gold has still carved a series of higher lows.  That 9.5-month-old rising lower support line is the bottom border of this colossal pennant formation.  Doesn’t it look like a symmetrical triangular flag hanging off the flagpole of last year’s huge gold surge?  This big technical formation seems to have real power, as seen after the latest FOMC meeting.

Gold was right at lower support heading into this recent mid-December FOMC decision.  Had a sizable selloff erupted in the Fed’s aftermath, it would have jeopardized this pennant’s integrity.  And after gold had plummeted 5.2% right after the mid-June FOMC meeting implied two distant-future rate hikes, how would it fare with the Fed expected to wax very hawkish?  Gold-futures speculators were nervous that day.

Gold’s only short-lived support breakdown came after the late-September FOMC meeting, when that so-called dot plot of individual Fed officials’ federal-funds-rate projections barely pulled forward the first rate hike to 2022 and left one in 2023.  Traders expected last week’s new dot plot to double that to two rate hikes each in both years.  Fed officials are worried about the raging inflation their money printing unleashed.

Bearishly for gold, this latest dot plot proved way more hawkish than forecasts.  Instead of doubling the rate-hike outlook, it literally tripled to fully three hikes projected in 2022 followed by another three coming later in 2023!  If there was ever an excuse for speculators to puke out another huge slug of gold-futures selling, that was it.  Gold had collapsed in mid-June going from zero to two hikes, and this was two to six!

Yet instead of freaking out, speculators accepted the looming Fed-rate-hike cycle and started buying gold futures.  Over the three trading days including the FOMC, gold actually rallied 1.6%!  That stark contrast to mid-June’s plunge on a far-less-hawkish dot plot was momentous.  It happened because specs had already done most of their gold-futures selling in anticipation of a hawkish Fed, exhausting their capital firepower.

That kept gold’s giant pennant intact on a high-risk day where a serious technical breakdown could’ve easily occurred.  This strong formation has survived plenty of challenges, increasing its odds of running to completion.  And that’s coming soon, with gold’s major support and resistance lines converging to wind the yellow metal ever-tighter technically.  Sometime in this coming quarter, a major breakout will be forced.

And it is very likely to prove an upside one.  In technical analysis, pennants are part of a larger group of chart formations called continuation patterns.  That means prices usually exit these moving in the same direction they entered.  This secular gold bull’s huge surge higher to new records in 2020 was the flagpole for this pennant.  So its breakout is likely to be another major gold upleg, fulfilling this giant continuation pattern.

These wound-up technicals are very bullish for gold.  Technical analysis often works because enough traders follow it and buy or sell accordingly to make it something of a self-fulfilling prophecy.  But I’ve always figured chart price patterns are secondary, that underlying primary fundamental drivers need to agree with them.  Gold’s big tightening pennant is confirmed as bullish by speculators’ gold-futures positioning.

Again with bored investors not the least-bit interested in gold, specs’ hyper-leveraged gold-futures trading has dominated this metal’s price action since mid-June.  Their total longs and shorts as disclosed in the weekly Commitments-of-Traders reports are rendered in this chart.  Over the past several years, specs’ longs have been trending higher and shorts have been drifting lower on balance.  This is normal bull behavior.

The longer secular bulls persist, the more likely traders are to bet with them and not against them.  So speculators’ upside bets on gold or longs gradually climb as gold bulls mature, while their downside bets or shorts slowly shrink.  Note above that spec longs are relatively-low in their secular uptrend while spec shorts are right at the upper resistance of their secular downtrend.  This positioning is very bullish for gold!

When longs are relatively-low, specs have far more room to buy gold futures than to sell them.  They’ve already mostly exhausted their likely selling.  And when shorts are relatively-high, specs have way more room to buy to cover than doing more short selling.  So major gold-futures buying is much more likely in coming months than more bouts of heavy-to-extreme selling.  And that will catapult gold sharply higher.

Case in point was the recent fast gold surge into mid-November.  Starting with the early-November FOMC meeting where it formally launched QE4 tapering, specs flooded back into gold-futures longs.  In the next two CoT weeks those soared a huge 55.6k contracts or 15.6% higher!  That blasted gold up 3.5% in that short span.  Another gold surge of that magnitude or larger would drive that pennant upside breakout.

But what would motivate gold-futures speculators to aggressively buy with a new Fed-rate-cycle looming?  Several major gold-bullish factors are aligning, which I’ll detail in next week’s essay.  In a nutshell they are epic Fed money printing continuing to stoke raging inflation, gold tending to fare well during Fed-rate-hike cycles, and Fed rate hikes weighing heavily on overvalued stock markets which boosts gold investment demand.

The Fed has ballooned its balance sheet by a terrifying 110.6% or $4,598b in merely 21.6 months since March 2020’s pandemic-lockdown stock panic!  Effectively more than doubling the monetary base is why inflation is out of control.  Relatively-more money is competing for and bidding up the prices on far-slower-growing goods and services.  Gold is the ultimate inflation hedge, its gains well outpacing monetary excesses.

Fed-rate-hike cycles are no threat to gold, contrary to futures specs’ paranoia.  During the last Fed-rate-hike cycle where the federal-funds rate was raised nine times between December 2015 to December 2018, gold powered 17.0% higher during its exact span.  During the eleven previous Fed-rate-hike cycles since 1971, gold averaged great 26.9% absolute gains!  Higher rates weigh on stock markets, not the yellow metal.

And today’s lofty record Fed-QE-levitated stock markets are very precarious trading at dangerous bubble valuations.  That starts at 28x earnings, twice the historical century-and-a-half fair-value at 14x.  Heading into December, the S&P 500 stocks averaged bubblicious 32.7x trailing-twelve-month price-to-earnings ratios!  As stock markets roll over on Fed tightening, gold will regain favor as the best portfolio diversifier.

I’ll greatly expand on gold’s coming turn to shine next week, but for now realize major drivers of gold-futures buying are coming.  And once that pushes gold prices high enough for long enough, investors will start to return with their vast pools of capital to chase gold’s upside momentum.  So major fundamental justifications exist for gold’s giant pennant continuation pattern to follow precedent and break out to the upside.

And gold’s next major upleg will likely carry it to new record highs.  Including that recent one truncated by hawkish Fed-official rate projections in mid-June, this secular gold bull has seen five uplegs.  They averaged big 29.3% absolute gains.  Assuming gold’s late-September low after the FOMC pre-announced QE4 tapering holds, a merely-average sixth secular-gold-bull upleg would propel this metal up near $2,231.

But given this super-bullish fundamental backdrop for gold including unprecedented inflation, this next upleg ought to grow even larger.  So the coming upside breakout from gold’s massive bullish pennant pattern is a really-big deal.  It will galvanize interest in this leading alternative asset, fueling major self-feeding gold-futures buying which will start attracting back investors.  Gold is wound tight and ready to surge.

The biggest beneficiaries of much-higher gold prices ahead are the fundamentally-superior mid-tier and junior gold stocks.  They rallied sharply with gold into mid-November, but were dragged back down to their stop losses by a bout of heavy gold-futures selling.  Our stoppings averaged out near neutral, mostly recovering our capital.  So we’ve been aggressively redeploying buying back in low in our weekly newsletter.

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The bottom line is gold technicals are wound up in a massive pennant formation.  It is well-seasoned, with upper resistance running back to August 2020 and lower support to March 2021.  These major lines will converge in the next several months, forcing a breakout.  That’s highly likely to be an upside one, as pennants are continuation patterns and gold entered this one powering higher.  These technicals are very-bullish.

And they are supported by strong fundamentals.  Specs’ gold-futures positioning has far more room for buying than selling.  That should be catalyzed by raging inflation from the Fed’s epic money printing, and bubble-valued stock markets rolling over on the Fed’s looming rate-hike cycle.  As gold powers higher on mounting portfolio-diversification demand, investors will increasingly return sustaining and growing its gains.

Adam Hamilton, CPA

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