Gold and silver are range trading as we end the summer. The traders aren’t committing to any specific position. We appear to be stuck in this holding pattern with the metals for the last several months. We had nice bumps in gold and silver at the beginning of July and the end of August. You will notice the metals often move in exactly the same direction at the same time. I will explain why this is the case in today’s analysis, along with how it benefits certain traders to continue this pattern.
Gold and Silver Analysis
Here is the gold chart and the COT (commitment of traders) report for the week, with commentary to follow.
Gold is in a consolidation pattern that I highlighted in orange, and we discussed that last week. This week we take a bit of a deeper dive to explain how that may benefit different trading houses. Trading houses make money on volatility, meaning when prices move up and down within a prescribed range. They like the ranges because it allows them to set their stops.
In other words, they can predict when and how much the price will move, and trade accordingly. This reduces their risk of entering positions. Remember, this market is a leveraged one where the paper trades are made on certain price targets, but most metal never changes hands. It is not about buying or selling the metal, it is about making money on the price movements.
On the other hand, the legitimate hedgers in the market, known as the Producer/Merchant category on the COT report, are buying and selling futures to protect themselves against price movements. For example, a merchant wants the lowest prices he can get, so he will protect against higher prices by purchasing a long contract that will pay him when the price rises and offset the cost of buying higher-priced metal. The reverse is true for producers, who are worried about prices falling and lowering revenues, so they purchase a short contract that will pay them if the price falls and offsets their risk.
The astute observer will note that this category of traders is conducting ‘legitimate’ price hedging for what amount of the physical they will actually buy and sell. Most everyone else buys and sells much less of the metal and is placing bets at the table on whether prices rise or fall.
While some other traders may have physical positions in the metal, a cursory glance of trading volumes from the COMEX will illustrate just how much more paper is being traded daily than physical is delivered. See illustration from the market below for Friday’s trading data.
Not every month is a big delivery month on the American market known as the Commodity Exchange (COMEX). Therefore, traders take huge paper positions in future months betting on the price later on, while there may be relatively little physical delivery going on in the current month. This is the paradox of the market, and it provides opportunities for gamblers to take advantage of low physical volume to push the price around on the market.
This is where they make their money. I will illustrate the same in the silver charts below, showing it is trading in a range. The traders like to trade both metals the same, though silver is famous for having higher lows and highs along the way, and is considered more ‘volatile’ for that reason.
The thing we watch for is when these patterns are broken, and it means that we have an event on the market for which the traders are not in control. In short, it either means the stock markets are so robust that traders will ignore metals and let them fall, or it means that something eventful happened to raise risk and traders demand higher prices. This should be fairly obvious at this point to those readers who have been following my analysis of the markets this year.
What we are really looking for are indications the metals are going to break one way or the other. And we see that in the tightening of the market. When the price ranges compress, and form a ‘wedge’ pattern, we expect the market to soon break one way or another. It could be a risky event that forces the metal price higher. Or conversely, a knockout month for stocks which sends the metals lower.
Given what is going on in the world now, which way do you predict the market will head this time when it breaks out from its summer range pattern?
Macro Outlook
There isn’t much to report this week on the macro front as last week saw little news of importance. The main items to highlight are:
- Factory orders were down across the US by 4.4%, falling to negative 2.1%
- The US trade deficit widened by $1.3 billion to $65 billion
- S&P Final Services PMI index fell to 50.5, which signals stagnation in service sector growth
- Initial jobless claims fell from 229,000 to 216,000
- US Productivity index fell to 3.5% on higher than expected US labor costs inflating 2.2%
Story of the Week
According to a story by Cointelegraph, the United States House Financial Services Subcommittee on Digital Assets, Financial Technology and Inclusion will hold hearings on September 14th this week to discuss the future of the digital dollar. Amongst the discussions, the committee will discuss the rollout of the digital dollar in the US. Readers of this column will note that the digital dollar is the name for the US Central Bank digital currency (CBDC).
While rumored for months, this is one of the first acknowledgments that the US government is considering implementing an official digital currency to replace the fiat US dollar currently in use. While the central bank, known as the Federal Reserve, has downplayed discussions on the adoption of the digital dollar, Congress is taking up the issue formally to move discussions forward.
The Fed has been testing centralized digital currency for some months but has largely kept the projects private. It was reported by Bloomberg on July 6th that a months-long test of the digital dollar had been completed by the central bank. Bloomberg noted the following.
“A monthslong test with some of the world’s largest banks found that digital dollars could be an effective way to improve domestic and cross-border payments, according to a unit of the Federal Reserve Bank of New York.
The Fed’s New York Innovation Center spent 12 weeks testing a technology known as a regulated liability network, which allows banks to simulate issuing digital money representing their customers’ own funds before settling through central bank reserves on a distributed ledger.”
Given the announcement of many CBDCs under testing worldwide, it is no surprise that the world’s largest central bank would undergo its own testing in preparation for a rollout of the digital dollar to US citizens. Implementation timelines for an official digital dollar are unknown, but this author guesses it will coincide with the next banking crisis as a potential solution to the current dollar system which is widely expected to come under heavy pressure in the next recession.
Recent reports of recessionary pressures in China, Europe, and many other world economies have led experts to predict a recession starting here in the US in Q4 of this year. Given the announcement of over 50% of the world central banks intention to reduce dollar reserve holdings in a recent World Gold Council survey, it is likely that the US will need to move to a digital version of its currency sooner rather than later as the paper dollar gradually falls out of favor.
Executive Summary
Gold and silver are exhibiting very interesting behavior for the careful analyst. While the metals have been range-bound all summer, this is in itself a significant development. Avoiding a summertime fade, gold and silver look to rebound sharply on the upcoming recession and current trading patterns indicating a breakout may be coming within a few months.
Overall, the macro outlook has not improved as both manufacturing and service sectors continue their slow and steady decline. Both indicate that GDP is shrinking and should soon turn down into negative territory. While the government usually waits two-quarters of negative GDP to announce a recession, the current administration failed to do so last year when GDP went negative 1.6% and then 0.6% in consecutive quarters. It is likely that once GDP turns down again, it will stay down and not return to positive territory until the current underlying issues with the economy are dealt with.
Amongst all of this news is the announcement that the House is considering the digital dollar upon successful completion of tests of the CBDC this summer by the Federal Reserve. It is quite obvious at this point that the Fed’s denials of implementing a centralized digital currency should be ignored as the US dollar comes under tremendous international pressure. Expect a formal announcement of the new US digital currency sometime during the upcoming recession.
Coin of the Week
I absolutely love the 1 oz Gold Britannia coin for its immense beauty. You simply aren’t a serious gold investor without considering this gorgeous coin for your collection, and at the time of this writing, they are on sale at JM Bullion.
