Early on Monday in Asian trading, someone (or something, like a trading algorithm) sold quite a bit of gold in the futures market. Apparently the sale was so overwhelming that circuit breakers were triggered twice. Someone seems to have developed an odd predilection for selling a lot of gold futures at precisely those times when futures market liquidity is at its thinnest – as the same thing happened again after the close of official COMEX trading on Monday, in what is nomally a “quiet period”.
There are many ways in which such a seemingly strange trade (which ensures one doesn’t get the best price) can potentially pay off. For instance, it could generate a big profit for outright short positions taken at an earlier stage, by triggering the sell stops of other traders. It could also pay off if a large options position was previously bought, either on gold futures directly or perhaps on closely related instruments like gold stocks or ETFs on gold stocks.
A second capitulation after the 2014 capitulation move – click to enlarge.
The most interesting action took indeed place in gold stocks. The HUI Index produced an RSI of slightly above 11 on its daily chart, after declining for a record 10th day in a row. This RSI reading is the lowest in the history of the index (the previous record low was produced in 1998 at about 16). Moreover, gold stocks have now broken every historical bear market record in the sector. Not only is this by now the biggest decline on record, the sector (as measured by the BGMI) is also trading at a record low relative to the gold price – undercutting the previous record low established in 1942 in the mini-crash following the Pearl Harbor attack.
The reason why this move deserves to be called another capitulation is that it has something in common with the 2008 and 2014 capitulation lows: in both cases record high trading volume was recorded (not in all gold stocks, but in selected stocks, resp. ETFs). This time it was the turn of the GDX, of which nearly 170 million shares traded on Monday, dwarfing all previous trading volume spikes by a huge margin:
Trading volume in GDX explodes – click to enlarge.
A number of the declines in individual gold stocks seemed downright silly – e.g. ABX, the world’s largest gold miner by output, saw its shares decline by almost 16%. This is remarkable even by the sector’s standards of volatility, but it is even more so if one considers that ABX was already trading below its low of 2000 before Monday’s decline. When ABX made its low in 2000, the gold price was at $270. We are not particularly enamored of ABX by the way (we think it has way too much debt), we’re merely using it for the purpose of illustration here.
Naturally, there is no evidence yet that a low is in – but one can certainly compare the current situation with similar events in the past. Irrespective of whether such extremes were recorded during bull or bear markets, a sizable rebound has tended to happen very soon thereafter.
This is to say, traders can probably look forward to a playable and possibly quite respectable bounce fairly soon, regardless of the market’s longer term direction. The caveat to this is that just as usually happens in a blow-off move in a bubble, very large percentage moves tend to occur in the final stages of anti-bubble blow-off moves as well, and a mere one or two days can make a big difference with respect to the entry prices on offer. Usually it is best to wait for some evidence that a turn in prices has actually begun.
Support Levels, Sentiment and Fundamentals
We have recently discussed gold’s lackluster reaction to the (for now) fast receding “Grexit” threat (see “Gold and the Grexit Threat” for details), and on this occasion pointed out that it was certainly possible for the gold price in dollar terms to move to the next major “price attractor”, namely the support/resistance level established in March of 2008 near $1,040-$1,050. This level was almost reached on Monday morning (the low was around $1,080).
We presented a few sentiment and positioning data as well in that article, several of which will only be updated later this week. We have near real time data on Rydex precious metals assets, which have declined by another 15% to a new record low, as well as the CEF discount to NAV, which stands at minus 10.30% (CEF is a closed end bullion fund holding both gold and silver bullion). This is not quite a record yet, but a pretty extreme reading nevertheless. People are prepared to voluntarily sell you gold and silver bullion at a more than 10% discount, a sign that they remain very bearish indeed.
It is a fair bet that a number of other sentiment and positioning indicators will also produce new negative records this week. Kitco reported on Friday (i.e., before Monday’s clubbing) that in its survey “68% Of Main Street And Wall Street Are Negative On Gold”, which if memory serves is quite an extreme unanimity of opinion in this particular poll as well.
Not surprisingly, the mainstream financial media have been brim-full with bearish pronouncements on gold over the past two weeks, and the grave dancing by assorted gold bears reached something of a crescendo on Monday as well. Here are two examples:
“Gold Slump is Here to Stay” (sure?), or the droll
“Let’s Be Honest About Gold, It’s a Pet Rock”
There is no need to discuss the usual canards forwarded by mainstream gold bears again (“gold is only worth what someone is prepared to pay for it” – duh!), but we would note that most of the grave dancers somehow failed to grace us with their opinions while gold rallied from $250 to $1,900 between 1999 and 2011.
It is certainly true though that the fundamental backdrop for gold (credit spreads, the steepness of the yield curve, inflation expectations, money supply growth rates, performance of alternative investment assets, the US dollar’s trend, faith in central banks and other central planners, etc.) has tended to be slightly bearish and at best occasionally neutral over the past two to three years.
Obviously, this applies somewhat less to gold in terms of currencies other than the US dollar; for instance, the ECB is inflating the euro area’s money supply at warp speed, and this certainly has an effect on the gold price in euro terms. The ministrations of the BoJ have also left their mark on the yen gold price. Although the recent decline has also led to a decline in gold prices in these currencies, prices remain a good sight above their previous lows.
Gold in euro and yen terms – click to enlarge.
Whether one thinks of the recent decline as an opportunity – or at least a developing opportunity – depends on more than just the short term fundamental and technical picture though. In our opinion, it is apodictically certain that the current global experiment in central banking on steroids will end with a major denouement. Very likely it will dwarf all the busts we have witnessed in the post WW2 era to date.
Of course this opinion is quite contrary to the widespread new-found faith in central planning that has reigned in recent years (investors evidently have very short attention spans). However, this misguided faith is only one of the elements driving the situation. In the short to medium term, it may even appear justified to observers focused on various indicators of economic activity – just as Greenspan’s easy money policy seemed to “work” until it didn’t anymore.
Underneath the superficial data, the economy has been and continues to be severely undermined by distortions in relative prices, the associated falsification of economic calculation and the malinvestment this engenders. It was easy to buy “too early” in the cyclical gold bear market since 2011. However, we believe that a day will come when this will hardly matter. On that day, the price at which one has bought will be secondary to the question of whether one actually has any gold at all.
Obviously, this latter remark reflects only our personal opinion and will depend greatly on the future actions of policymakers, which cannot be foreseen with certainty. However, what we have said above about the effects of loose monetary policy on the economy is definitely not just a matter of opinion.
An empirical indicator of the imbalances in the economy’s production structure due to credit expansion-induced malinvestment: the ratio of capital to consumer goods production – click to enlarge.
For those already invested in the gold sector, the current breakdown is undoubtedly painful, but this shall pass. Those not yet invested or holding only little exposure should definitely regard the situation as an excellent opportunity. Even for short term traders a chance to play a sizable rebound is likely not too far away.
In the longer term, this downturn remains in our opinion comparable to the mid-1970s correction, which was of roughly similar size. Back then the press was also full with gold obituaries, but the price took off again because the underlying economic problems had not been solved.
Have the underlying economic problems been truly solved this time around? We really don’t think so. Global debt levels have increased sharply since the last major crisis, which was likewise induced by a combination of too much debt and enormous capital malinvestment. We would argue that the underlying economic situation has gotten worse, not better. Economic activity by itself is telling us very little – during credit expansions it merely tends to mask capital consumption. Gold will therefore shine again, even though it has obviously greatly disappointed its fans since 2011.
Charts by: StockCharts, St. Louis Federal Reserve Research