As I wrote in my recent article, a rising dollar can have a short-term negative effect on the price of gold and silver. Traders often look at a ‘strong’ dollar and believe that the market will continue to demand dollars. After all, the dollar is the world reserve currency and is considered a safe haven in times of market stress.
The stock markets have been selling off all year. Bond rates are rising which introduces a fairly serious amount of commercial and sovereign debt risk. Even real estate prices are starting to come under pressure across the US. It appears we are in a recessionary liquidation phase where investors sell to cover margin calls and other losses, while also moving to cash and equivalents for short-term liquidity.
Businesses are seeing slack consumer demand and it is likely the corporate sector begins to tighten its belt substantially for the rest of 2022 as earnings reports disappointed this quarter. US Companies have not recorded a positive quarterly earnings season dating back to Q3 of last year, and the trend for falling earnings dates back to the middle of 2021. Companies will need to spend less for the rest of 2022, or at least until consumer spending rebounds and stabilizes revenues.
The sell-off does not appear to be slowing down, perhaps primarily the result of the Fed’s policies of raising interest rates aggressively to their now 4.4% target. In addition, the Fed has now begun selling off some of its assets, reversing its position as a buyer of last resort in the treasury and commercial paper markets.
We will see if the consumer comes back at the end of 2022 for the holiday season, and rescues what increasingly looks like an economy that wants to start freefalling, and which has never fully recovered from 2020 shutdowns/supply chain problems despite monumental efforts from the central bank to print our way out of the economy’s problems.
Technical Analysis – Downside View
Against that backdrop, we look at gold from a technical perspective to see what the charts tell us. My view on technical analysis is that while backward-focused, it may provide clues, based on pattern analysis, of what traders may be thinking about the price going forward. It is a worthwhile exercise to examine what the numbers are predicting.
We examine what the downside price risk to gold would be in the chart above. This is the pessimistic view on gold, assuming we have entered a long, slow stage of stagflation that causes the market to slowly sell off over many months. This scenario would assume inflation eventually settles down and starts falling to meet the rising Fed interest rates somewhere in the middle. It is not likely the US government could stand a full 9% interest rate needed to combat over 8% CPI numbers because it would raise the government’s debt service substantially and threaten current tax receipts.
Higher taxes will not help the economy right now and would likely force businesses to close and actually reduce overall tax receipts. The economy is weak enough now that removing any cash flow from the system causes it to slow down and potentially lock up. The way forward is easing tax pressure and allowing both corporates and consumers to begin the long, painful process of fixing their balance sheets.
This also could be the freefall gold price if we have a sudden crash in the markets due to some unforeseen financial or economic event. Such an event could include a bank failure, a liquidity lockup in the repo markets, or a major geopolitical event among other things.
While less likely to happen in the short term, catastrophic economic events should be part of an analysis of all asset classes for the wise investor who builds risk management into their portfolio analysis. At the very least they should be the ultra-pessimistic bottom that is considered very unlikely to happen, but possible in the right economic scenario.
While the downside price target of around $1350 shown in the chart above is possible, I do not consider it very likely. First, the technical chart setup is quite a bit different prior to the 2008 crisis when compared with now. The last recession resulted from overextended mortgage and banking sectors that sopped up liquidity and caused the economy to grind nearly to a halt. While the mortgage market had its problems at the time, the debt situation has worsened considerably from 13 years ago.
Now we have a situation where the US is over the dreaded 90% debt-to-GDP ratio that Reinhart and Rogoff warned us about in their now seminal paper on the role of debt and economic growth. What it boils down to is we can expect higher inflation and the need for either a debt market restructuring or debt default pressures to ramp up substantially, calling into question the US’s ability to repay all of its sovereign debt.
While the dollar is ‘strong’ now compared to other currencies, confidence in the dollar is declining as both China and Russia have announced alternative currency arrangements to compete with the dollar on the world stage.
Not only is the debt situation an order of magnitude worse than last time, but the US (and many other central banks) have printed record amounts of new currency in response to both the 2008 mortgage debt crash and the stress caused by the lockdowns in 2020 in response to COVID. Both conditions have set the stage for a more bullish picture on gold.
However, don’t underestimate how long this market can stay negative towards gold (and positive to the dollar) until it has absolutely no other choice. Nobody wants to admit a failing dollar because it wil roil currency and debt markets, and likely cause excessive amounts of bank and interest rate risk across the world. The world certainly does not need that right now.
Technical Analysis – Upside View
Looking at the picture above, it is not likely that we see strong growth in the corporate sector, or the US economy, until the current debt situation is worked out. Companies are more indebted than at any time in history, and so are consumers. This is not a winning plan for returning to a growth oriented economy. Both producers and consumers are very closed to being tapped out and will need to tighten belts substantially before sustainable economic growth can return.
The positive view on gold is that it typically leads bull markets in the commodity sector. As we can see from the chart above, the gold/crb ratio has been hovering above the 50-day moving average and inching closer to challenging the 200 day. The CRB is the most widely followed commodity index, and the gold/crb ratio is one of our gold breakout indicators. When the gold/crb ratio breaks and stays above both the 50- and 200-day moving averages, we can expect that gold will lead commodities forward.
Many investors may not have realized that gold stocks outperformed the regular market for the first half of the year, falling eventually into parity with other stocks as the financial contraction continued throughout this year.
We have an interesting development in that the gold stocks are wanting to outperform the market again because the gold stocks have been making money for about a year now, and the market wants to allocate capital to the sector. Overall market bearishness may be pouring cold water on the gold stock rebound; however, and we will have to see how much they want to break through.
Many times, we see gold companies lead the physical metal into bull market cycles. This occurs when gold companies, who have been making money for as long as gold is trading above cost, begin to get noticed by money managers looking for a return in a falling market. They begin to rise, which brings the rest of the precious metals sector into the spotlight.
Final Thoughts
Will that be how gold starts its next leg of the multi-decade bull market cycle? It could be, and we will be watching patiently for confirmation of the next big gold bull market. Gold appears to be at an important inflection point. Either the market recognizes it as a safe haven asset that can be used to offset current market risks, or the market continues down the slippery slope of managing inflation and interest rates without trying to break the dam of high levels of sovereign and corporate debt, keeping gold’s next big move at bay for a little while longer.
