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Wake Me In September Please

I connected the right dots last week but got the direction wrong.

On the heels of weak ADP jobs numbers out last week on Wednesday, I guessed Friday’s official July jobs numbers would also surprise to the downside. And I thought that would be good for gold because weak job numbers would remove almost all impetus for raising interest rates.

The converse I also said would be true: that strong jobs numbers would be bad for gold because they would support the idea of tightening. Unfortunately, that’s what happened. On Friday we learned that the US economy added 943,000 jobs in July, pushing the unemployment rate down to 5.4%. Analysts had expected 845,000 new jobs and unemployment at 5.7%.

In response, gold dropped almost US$40 per oz.

The drop I’m discussing happened on August 6 and is circled in yellow. It pulled the yellow metal from US$1800 per oz. down to US$1760, a level that has provided support since the spring (marked in orange below).

For gold to be sitting just on that support level was apparently too tempting for a group of gold bears out there who decided to attack. On Sunday night, someone dumped 24,000 gold contracts nominally worth US$4 billion in the Asian market in a completely price indiscriminate manner.

Why would someone do this? To clear out the entire bid stack, which means to sell into every bid to clear the path for a price freefall. When a price free-falls all kinds of stop-loss orders – the sell orders at set downside prices put on holdings to protect against calamity – get hit, which then creates more selling as computers enact those stop-loss sells.

Such an attack can happen any time but the attackers certainly choose their moment. On Sunday night gold was vulnerable, as technical traders often have Sell orders sitting just below key support levels like the one upon which gold was sitting. Friday’s jobs report loss had also pulled gold’s 50-day moving average below its 200-day moving average, creating the “death cross” indicator that technical traders also often take as a sell sign.

It worked. Gold dropped as much as 4% in early Monday trading, losing US$74 per oz. in minutes and briefly plunging as low as US$1677 per oz.

How do we know it was an orchestrated attack? There are a few clear pieces of evidence. The first is the scale of the sell order – no one sells 24,000 gold contracts with a notional value of $4 billion in a flash unless to rock the market. Second, nothing else was happening in the markets that would have rationalized selling a huge pile of gold – yields and the dollar did nothing interesting and there were no new data points of import. Third, it was timed such that very few traders were at their desks, which makes it easier for attackers to reap max benefit.

So the bear attack send gold plummeting. As the first chart shows, it recovered much of the lost ground in a few hours but the damage was done and it traded sideways and down for the next few days.

That trend changed today following US inflation numbers that showed inflation perhaps starting to ease. In July the Consumer Price Index increased 0.5% month over month and 5.4% year over year, right as expected (analysts had forecast 0.5% and 5.3%). If you recall, the month-over-month gain in June was much hotter at 0.9%, so 0.5% represents an easing of inflation.

That fits the Fed’s narrative – that at least some of the hot inflation we’ve been seeing is transient – and fitting the narrative means the data does not pull rate hikes closer. That’s nominally good for gold, as the longer we have zero interest rates the longer we are guaranteed a negative real interest rate environment.

Of course, if negative real rates were the only thing that mattered for gold, the yellow metal would have done much better in the last while. It didn’t gain when real rates fell in July. But that’s because investors instead focused on what might happen next with real rates, rather than what was happening in the moment.

Understanding what is happening is hard enough. Predicting what is to come amidst the barrage of opinions is nearly impossible. Most mornings my inbox has reasonably convincing arguments across the spectrum, from Inflation is hot and here to stay! to Growth has peaked and there’s deflation dead ahead.

It’s enough to make me not want to care! But given I’ve built my entire portfolio and business around metals, not caring isn’t an option ;)

So here are the thoughts I’m left with today:

  • Either inflation path works for gold.
    • If high inflation persists, the Fed will raise rates – and that’s ok because in the last decade rate hikes have kicked off new gold bull runs. Of course, it’s not the higher rates that do it; it’s the inflation that does it. And investors get the confidence to buy gold as an inflation hedge once there’s enough inflation that the Fed has to act.
    • If inflation eases off, the Fed won’t raise rates. The slowing growth that would come in this setup should prompt investors to seek security, like gold and cash-rich, dividend-paying gold miners.
  • The base metals that have been strong in 2021 (copper, nickel, uranium, coal, iron ore) are generally in good stead, perhaps not in the very short term (cause whoever knows, plus summer doldrums), but in the medium and long term. Supply-demand fundamentals are generally bullish, especially because they are powered by global electrification and population growth as opposed to the ebbs and flows of US consumer behaviour.
  • The short-term risk right now is real. The charts (gold, silver, copper, nickel, etc) are not particularly strong, the summer doldrums are clearly here, and there is all manner of uncertainty about what the fall will bring in terms of COVID, inflation, growth, and rates.
  • Just a little farther out, the outlook improves markedly. Gold adores September – all the vacationing traders return to their desks and re-establish positions, kicking off gold’s strong season. Copper is also reliably strong in the fall.
  • Exploration results are about to ramp up, as northern hemisphere projects star producing summer numbers.

That last point introduces the most excitement (and volatility). We buy explorers for the chance at discovery. To take that chance, we also have to bear the risk of failure.

The fact that assay labs remain slow this year is perhaps a blessing – whether results are good or bad, they get better reception in a buoyant market. And as I just outlined, the market is always more buoyant in September than in the dog days of summer.

So here’s to a flood of drill results in September and October bringing some excitement back to a boring market!

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-PM (June 1, 2020)