October 14th, 2021
Chart Analysis: Predicting Gold’s Next Bull Run
Dear Retail Investor,
To be a gold investor one must possess the virtue of patience. You would think with the amount of debt and money printing that has happened since the beginning of the pandemic we would have seen gold go a lot higher.
Gold after all is supposed to do well in an inflationary environment. And aren’t we seeing higher inflation now as the price of everything is going up. “Don’t worry, it’s just transitory”, the Fed keeps telling us.
Gold did have an impressive 20% run during the beginning of the pandemic, peaking at just over US$2000 an ounce before drifting back down the mid 1700’s, which is roughly where it sits today.
It’s been quite boring being a gold bug of late – there will be days when gold prices move up 2% and there is excitement in the market that gold has finally broken out, but these gains are lost a few days later. This can really eat away at any optimism, especially when gold equities keep selling off and seem to go lower and lower. However, things aren’t as bad as you think for gold if you sift through the market noise.
Follow the trend
Let’s keep it simple. The trend is your friend. The trend is a long-term one. Gold is still in a bullish cycle. A basic technical analysis pattern can illustrate this. Technical analysis is a great way at to understand the price behavior of a security. It is not an exact science, but it can help you gauge where prices could be going. Looking at a 3-year time frame, the gold futures price is forming what is called a pennant (like what you see in baseball).
The pennant formation is a continuation pattern to the upside. The long blue line to the 2020 high is the flagpole. The two converging blue lines are the pennant. This pennant is a consolidation period. Also notice the shaded blue at the bottom where volume has been steadily decreasing since the peak. If volume starts to tick up in gold futures as price converges towards both trend lines, then gold could break-out.
A price target on pennant formation is usually measured by the height of the pole from where the price breaks, which is where the converging trend lines meet. In this case, the converging price is likely to be between $1780-1830. You then subtract the base of the pole, which is $1200. The difference is around $600. This would be the expected move in the price for gold, which would put the yellow metal at $2400-2500 an ounce for a potential 35-45% increase in price. When will this happen? I wish I had a crystal ball to tell you. A fundamental event will be the likely cause for the next big spike.
Here are four key things to watch for the next potential break-out (in no particular order).
1. 10-year bond yield goes lower
The 10-year bond yield and gold have historically had a negative correlation with each other. A 10-year bond is considered a safe haven asset like gold. When yields go down, prices of bonds go up as investors look to park their money somewhere safe. Investors will also pile their money into gold. If the US Federal Reserve is expected to keep interest rates the same or lower them, then yields should continue to slide lower or remain low. Moreover, gold will become a much more appealing safe haven because real yields (nominal yield – inflation) are negative. This means because of inflation, holding a 10-year bond actually gives you negative return. So if you have a bond that is yielding 1.5% and inflation is 2%, then your real return is actually -0.5%. Who would want that? You can check out Treasury real rates here.
2. Market correction
A market correction brings about economic uncertainty. Investors tend to sell out of equities and other risk assets and buy gold to protect themselves from economic crisis or inflation. The US stock market has nearly doubled in value since the lows of the pandemic. Bull markets don’t last forever and the headwinds such as increasing energy prices, supply shortages, and inflation could all impact the economy negatively causing a stock market sell-off.
If inflation expectations start to trend higher, it should pull gold with it. Right now, the market seems to be listening to the US Fed’s narrative that inflation is transitory. A sign that inflation is not transitory is if we start to hear central bankers walk back the current narrative about inflation. In Canada, for example, the central bank has recently admitted that inflation is more persistent than expected (see here).
4. US dollar gets weaker
The US dollar was once ‘as good as gold’ until former US president Richard Nixon took the worlds ‘reserve currency’ off the gold standard in 1973. The relationship between gold and the US dollar still exists. When the US dollar gets weaker, gold tends to increase in price because the metal is still seen as a substitute for US dollars. The US dollar index is important to monitor if you want to see where the price of gold could be going.
All eyes on the Fed
For gold to increase in price it will likely come down to both fiscal and monetary measures taken by the United States. Janet Yellen, the Treasury Secretary wants to do away with debt ceilings, which would allow for loose spending and bigger deficits and debts. The Federal reserve seems to have no problem being on stand-by to print endless dollars and keep interest rates perpetually low.
The Fed’s motto has been ‘inflation is transitory’, which may in fact be the reason gold has been in this consolidation phase, as inflation is expected to fall by some market participants. If the Fed is wrong about inflation being transitory and they have to walk-back any of their previous statements about inflation’s temporary state, then gold could start percolating and move to new highs.
3 options for gaining exposure to gold
So you have read this far and you may agree that money printing, big debts and a weaker US dollar will push gold to new highs. You obviously want to profit from the potential scenario outlined earlier where gold could move to 35-45% from current levels. When will this happen? No one knows. If your conviction is super strong and you have a high risk tolerance you could buy Direxion Daily Junior Gold Miners Index Bull 2X Shares (NYSE Arca: JNUG). This is a leveraged play on junior mining companies. Junior companies are more volatile and have bigger price moves than large-cap ones. If gold breaks out JNUG should perform exceptionally well because of the leveraged factor. But alternatively, if gold prices fall the JNUG price could move a lot lower, so be warned.
Gold Producers are a simple way for exposure to either by individual security or ETF. The gold producers have been beaten down badly and offer good value. The VanEck Gold Miners ETF (NYSE Arca: GDX) is down 44% since its peak in March of 2020. It holds big names like Newmont Corp. and Barrick Gold.
Finally, a lower risk model to gain exposure to gold is a royalty company. Gold is only down 15% since its peak which indicates the equities have performed much worse than the gold price over the last year or so. Royalty companies have diverse assets, low capital expenditures and ongoing royalty revenue. They perform exceptionally well in bull gold markets and can weather downturns in the market too. An up and coming royalty play is Elemental Royalties Corp. (TSX-V: ELE; OTCQX: ELEMF) who have gold producing assets all around the world.
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