2023-12-11 23:35:22 ET
Summary
- Gold's failure to hold above $2,000 despite a surge in bullish sentiment suggests short positions are once again warranted.
- Price action is reminiscent of the previous significant peak in March 2022, which gave way to a 22% decline.
- Despite the decline in bond yields, gold remains extremely overvalued and is highly susceptible to any pause in the recent yield decline.
After shifting to a neutral stance on gold in early November, the metal's failure to consolidate gains above the $2,000 level puts the focus back on the downside. The spike to new record highs of $2,135 on December 4 occurred amid a spike in bullish futures positioning as well as a spike in the call-put ratio in options pricing as speculators scrambled to gain exposure to further upside. With gold having now reversed these gains, there is significant potential for a reversal in bullish sentiment to drive gold lower. Fundamentally, while the decline in real bond yields over recent months has improved the backdrop for gold, the metal remains far above the levels that have historically been associated with current real yields, while markets are already pricing in aggressive Fed cuts. The balance of risks heavily favors lower gold prices over the coming months.
Bearish Reversal Candle Combined With Extreme Bullish Sentiment
Gold's chart pattern is highly bearish after failing to hold gains above $2,000. The false break is reminiscent of the one seen in March 2022, following which the metal lost 22% over the next 6 months. There is little meaningful support now until the $1,800 area marks the October lows.
The failure to sustain gains above $2,000 is doubly concerning when considering that futures and options markets show speculators remain positioned for further gains. Net non-commercial positioning is now at its most bullish since April 2022, having recovered strongly from the October lows, and this should be seen as a contrarian indicator.
Gold Vs Net Non-Commercial Positioning As A Share Of Open Interest (Bloomberg)
So too should the action in options markets, where speculators have rushed to gain upside exposure to the metal. At the October lows, speculators were paying much more for 1 month 25 delta puts than they were for calls as they looked to protect against further declines. In contrast, at the December 4 highs, the price of calls far exceeded the price of puts. Even after receding somewhat since then, the call-put ratio is still 1 standard deviation above its 10-year average. This suggests that there is significant room for speculators to reverse their current bullish positioning, which should drag the price of gold lower.
Lower Bond Yields Have Done Little To Improve Gold's Fair Value
The bearish technical backdrop is particularly concerning when considering that fundamentals suggest gold should be significantly lower than current levels. This view is based on the correlation between gold and 10-year US inflation-linked bond yields, as well as the correlation between the gold/industrial metal ratio and 10-year nominal bond yields.
Over the past few months, bond yields have fallen significantly, but at the same time long-term inflation expectations and industrial metals prices have also fallen. As a result, there has only been a mild improvement in gold's fair value, which is still significantly below current levels. The chart below shows gold relative to the fair value estimated based on its correlation with real yields, nominal yields, and industrial metals over the past 10 years. The current fair value reading is around $1,000.
Too Many Cuts Priced In
I noted in a previous article on the GLD ETF in September that while the metal is extremely overvalued relative to its fundamentals, those fundamentals could improve dramatically as the Fed cuts rates. The US' dire fiscal position strongly suggests a return to negative real 10-year yields, from 2% positive currently, and such a move would be more than enough to allow gold to rally. However, markets are already pricing in aggressive Fed rate cuts in 2024 and beyond, which suggests that any improvements in economic data or higher-than-expected inflation prints could halt the recent yield decline, seriously undermining gold prices.
For further details see:
Gold: A Major Bearish Reversal Pattern