Gold's Seasonality Shift

by John Lee

09/19/2006

Dollar and Bonds:

The dollar broke its head and shoulder neckline in May of 2006 and has not recovered. We don’t see any reason fundamentally and technically for the dollar to head above its 200 DMA of 87.5.

The Euro has been taking its time to breakout of the important 1.30 level.

US bonds have rebounded since the Fed’s paused its rate hikes. Until long bonds decisively break down, we continue to see a soft landing in the US housing market.

From the July 24th Update:

“While the seventeen straight interest rate hikes by the Fed since June of 2004 provided little help to calm gold and commodity prices, the effects are now being felt in markets across the board from housing to high-tech. The S&P 500 has broken down out of its 3 year uptrend and cannot sustain further rate shocks.

In April of 2006, after an uptrend that lasted 16 months the dollar index broke down. This breakdown is significant, and given our belief that the rate hikes will be finished by September, we see limited upside by the dollar, capped by its 200 DMA of 88.”

The Fed kept its benchmark rate unchanged on August 8th.  With oil comfortably below $70, we expect the Fed to remain on the sidelines throughout the rest of this year and to possibly begin cutting rates by next January at the first sight of equity market weakness.

We see the dollar range bound between 82 and 90 for the remainder of the year.

Gold and Silver:

From the July 24th Update:

“On May 12th gold hit a multi-decade high of $730 before falling back to $570 in June. Since then gold has been rather volatile, with daily rises and dips between $5-15 seen as the norm. Again increased volatility is norm when an important resistance has been overcome.

Throughout the summer, barring any major unforeseen developments in the Middle East, we expect gold to consolidate in the $560-700 range.”

Ever since the Fed paused the interest rate we have been bombarded with gold bearish news.  Oil prices have been declining, inflation data has been coming in low, and geopolitical tensions have been alleviating.  All of these factors have been used by the popular media to explain the recent declines in the precious metals and in some cases call an end to the bull market. 

The XAU:Gold ratio is at the low end.  Historically a low ratio means two things:

1. That the XAU is cheap relative to gold.
2. Both gold and the XAU are at/near the bottom.

Since the gold bull started in 2001, there has been a few times where gold dipped below its 200 DMA.  All of these times, gold recovered and climbed back above its 200 DMA within weeks.  Gold has solid support at $550 and we don’t expect that level to be breached.

XAU:

From the July 24th Update:

“The XAU index closed the week at 133 just above its 200 DMA (daily moving average). During the summer months of thinning volume it may be possible for the XAU to breach the 200 DMA. Nonetheless, any significant moves ahead of the expected run-up in autumn should be seen as brief and temporary.”

The XAU’s choppy action has continued into early September. The Fed’s rate pause threw gold off balance and we believe the current takedown is nothing more than a teaser thrown by the market to spoil hardcore seasonality traders. The XAU is now resting on strong support of 120, which we believe will prove to be the ultimate bottom.

S&P500, Nikkei, Shanghai:

From the July 24th Update:

“The S&P 500 is now feeling the effects of higher interest rates. Real estate markets are affected by higher ARM (adjustable rate mortgage) rates, and auto and consumer retail markets are affected by higher car and credit card loan rates.

The overall economy is also suffering from the effect of higher oil prices. The S&P 500 has firmly broken down from its 3 year uptrend and cannot sustain further rate shocks. It is our belief that Bernanke will halt the rate hikes by September and possibly start cutting rates by the end of the year.

With US markets seemingly slowing down rapidly, they are now allowing Chinese domestic consumption to pick up the slack from export markets.”

Many gold analysts have started talking about an equity market recession again. The S&P 500 simply disagrees with that assessment and the index is threatening to establish a new 4-year high. Window dressing by fund managers will likely keep the market afloat for the rest of 2006. We are not about to turn bearish on markets until the index breaks beneath the blue-marked uptrend.

The Shanghai has had a massive run in 2006 increasing 55% going from about 1100 to over 1700 and its uptrend is still intact. This showing is particularly impressive in light of various actions by the Chinese central planners; from imposing stricter stock listing requirements to restricting foreign investment in real estate to cool the economy.

CRB and Oil: 

From the July 24th Update:

“The initial outbreak of war between Lebanon and Israel about two weeks ago helped send oil to a record high of $78.40. Oil looks to be quite stretched above its 200 DMA. Prior times (Oct 2004 and August 2005) when oil was $15 above its 200 DMA, a correction back to 200 DMA (currently $66) ensued..”

Just as we predicted oil has slipped more than 20% from its record of $78.40 a barrel posted on July 14th. We don’t expect it to fall below $60 a barrel.

The CRB is now 10% below its 200 DMA, a feat that has never happened since the bull started in 2002. This is a significant event and must not be taken lightly. At this juncture, we interpret the shift in trends as follows:

1. CRB, oil, and base metals have peaked for at least the next 12 months.
2. The precious metals have one more run left that will begin later this year and last into fall of next year.
3. Agricultural commodities typically shine last and will take the leadership role in the CRB from here on.

Conclusion:

Historically, the gold market has followed a strong seasonal cycle.  The old adage traders live by is “sell in May and walk away, buy in September and harvest by spring.” The lack of positive gold market action in September has caught many by surprise. Is this the end of the gold run or merely a slight delay before the bull resumes?

As we outlined, the XAU over Gold ratio indicates gold is near the bottom, not the top. Fundamentally and technically, the dollar remains bearish. Moreover, the gold equities simply haven’t exhibited the type of action we call the “maniac blow off”; a select number of juniors remain exceptionally cheap with current metals prices taken into account.

This is not the first time during the bull run that a fall breakout has been delayed.  In late 2002 the XAU traded between 60 to 80 from September to late May until it finally broke out in April.  When the breakout finally occurred it was astounding.  The XAU rose 70% going from 65 to over 110 in 6 short months. If XAU were to follow the same suit this time, we would now expect it to consolidate between 120 and 170, eventually taking out 170 around next April on its way towards 300, again defying those who choose to sell in May, and walk away.