Is the Gold Correction Done?
It's close, in our opinion. We are starting to see the usual panic from gold newsletter writers and the bears are back calling for much lower gold prices.
Is the Gold Correction Done?
It's close, in our opinion. We are starting to see the usual panic from gold newsletter writers and the bears are back calling for much lower gold prices.
We predicted the correction here on October 25. The excuse the market needed turned out to be the Fed statement of October 28, 2015 in which the merry pranksters took a slightly more hawkish tone in order to put a possible December rate hike back on the table. The market bit on the lure. But the real issue was a large speculative position that was looking precarious after gold failed to punch through its 200dma. The speculators began selling, which put pressure on gold.
We have three observations. First, regarding the Fed, we see very little chance of a rate increase in December, or any time soon. Consumer price inflation remains well below the Fed target and US economic data is not strong.
The Fed is playing a game known as rational expectations. They believe that if we believe they are going to raise rates, we will continue to believe that the economy is strong because the Fed is going to raise rates because they say so. And if we believe the economy is strong, we will act as if it is and it will be strong. As a bonus, they will not have to raise rates because if we think they will, the market will do the tightening for them.
So, the secret to this strategy is simple: always promise but never deliver a rate increase. Make it data dependent and publish optimistic projections. Eventually, the economy will have the accelerated recovery the Fed keeps promising in its projections. Why will it recover? Because we believe it will.
You may think this dissertation on the Fed sounds ridiculous. However, you can find lots of Fed papers on rational expectations theory and it certainly does explain Fed speak and behavior (for example, see https://research.stlouisfed.org/publications/review/85/05/Rational_May1985.pdf.). The Fed is not so much about actual monetary policy but rather the perceived direction and impact of monetary policy on the economy. As long as you believe in their power and omniscience, all is well.
How is this relevant to the current gold correction? In our view, if the Fed does not raise rates this year, it will lose credibility and that remains the key to better performance for gold. Markets will not forever continue to expect things that never come--accelerated recoveries and rate hikes.
Second, the distended speculative long position is being worked off but not that quickly, certainly not as fast as we have seen in the recent past. This suggests that gold is no longer in a bear market and that this drop in the gold price is a correction and not a new bear phase. Has the long position been reduced enough? We don't know but our sense is that we will not get a selling climax this time because market sentiment has shifted in a bullish direction. The COMEX open interest remains somewhat high but it may not have to hit bear market levels to signal a turn.
Third, the gold stocks have held up relatively well against gold, unlike previous declines in the gold price. This divergence is usually a reliable indicator of a bottom being close at hand.