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Chart Of The Day: Gold Pressured By The Reflation Trade

Published 02/08/2021, 09:33 AM
Updated 09/02/2020, 02:05 AM

Market fundamentals are currently lining up to pressure gold. As such, we expect the precious metal to head lower in the short- to medium-term. In particular, there are a pair of reasons bolstering the technical projections of another slump.

With markets now rising on the “reflation trade,” in which the Democrats’ massive stimulus plan is designed to revive economic growth after the current downturn, inflation is expected to reappear—for the first time in over a decade. That will be followed by rising Fed interest rates.

The economic recovery, amid reflation and the abundant, available cash for investing will boost equity prices. Increasing consumer spending will further buoy company profits, propelling equity prices even higher. Bottom line: stimulus will ramp up risk appetite.

In this scenario, we expect the dollar will strengthen while gold will be be sold off, both because the yellow metal's status as an inflation hedge is irrelevant under current economic conditions and because its standing as a safe haven asset isn't sought after during risk-on periods.

Gold's technical chart backs up the decline:

Gold Daily

On Jan. 4, gold’s upside breakout from its falling channel failed when the shiny metal slipped back into that bearish channel on Jan. 8. It tried once more to break out but found resistance by the channel top.

Moreover, the 200 DMA reinforced the channel top at that price level. Finally, the 50 DMA crossed below the 200 DMA, triggering a death cross—all at the very same spot.

Since then, the price developed a rising flag. That's bearish after the 6% plunge within just three days that preceded the flag’s development, as sellers took profit, which included a buy order that supported the price, while new short sellers kept a lid on the flag’s upward tilt. When whoever wanted to cash out did, the second batch of bears forced gold below the flag.

The price then found support at the levels of the previous two lows, that of the flag on Jan. 19 and the Nov. 30 low, giving rise to a return move to retest the flag’s integrity, or simply another effort at short covering, until the presumed continued conditions will force gold further down, where the price will post below the Nov. 30 low, extending the downtrend since the March peak.

We have been considering the potential for a H&S top, whose neckline is marked by red, horizontal bar, but the flag and its completion lowered the odds for that scenario. When the price falls below $1,767, the possibility for this will have been erased, though there would still be the risk of a double bottom.

The RSI shows the same flag pattern/return move in momentum, and the MACD’s short MA found resistance by its longer one, then fell lower, reflecting the channel’s failed breakout and resumed downtrend.

Trade Strategies

Conservative traders should wait for the price to register a new low, then rise and find resistance.

Moderate traders would short when the current return move tops out, with at least one long, red candle.

Aggressive traders could short according to their timing, budget and risk aversion, provided they've formulated a coherent trade plan.

Here’s just an example:

Trade Sample

  • Entry: $1,850
  • Stop-Loss: $1,880
  • Risk: $30
  • Target: $1,760
  • Reward: $90
  • Risk:Reward Ratio: 1:3

Author's Note: This is just a trade sample, not the analysis. Even if it is sound, it only weighs the evidence. We cannot tell the future. And the analysis might be wrong altogether. The objective of professional trading is to join statistics, and make money overall, not on an impossible-to-predict trade-by-trade basis.

Trading is nothing more than managing your luck. The more you're able to manage, the less you are exposed to the market’s randomness. Understand that trading is a business like any other, which requires education, experience and investment. Happy trading!

Latest comments

And what about negative real interest rates at record lows?? I think real rates continue to go down. That will put additional pressure on the dollar and help precious metals.
Most of the dollar strength for the past few weeks has been a reaction to other countries trying to stop their currencies from strengthening against the dollar. Most every country including the U.S wants a cheap currency to help exports and deal with large debt loads. There has been a hockey stick up and to the right in the amount of money supply. Just last November the Fed released an academic paper warning that the U.S had about ten years to get its fiscal house in order before debt to GDP levels became unsustainable. It further warned that policy makers (ie. politicians) should not be tempted to have the fed be the buyer of increased U.S debt to fund bigger and bigger deficits. The paper authors said this was a recipe for disaster and listed the Weimar republic and more recently Venezuela and Zimbabwe as examples of what can happen when a central bank creates money to buy its own countries debt. Well the debt to gdp didnt take ten years it only took ten months.
I notice now the Fed is at pains to explain that its huge balance sheet expansion and purchases of not only treasuries but corporate debt is not a violation of its charter nor is it creating money to fund deficits. Just a few months ago the fed also insisted it would never engage in yield curve control to try and bring rising interest rates under control. We now see with the rising long end of the curve that too is another "fed rule" that the fed  has changed its mind on. The fed is like a plate spinner on the old variety shows trying to keep all the plates in the air at the same time. There is little inflation or so the fed claims. Meanwhile I filled up my gas tank last summer for 1.69 and gas is now 2.39 in my city. Grocery sales prices today are the old full retail prices before the virus. My house has gone up now in the last year  more than someone can save in lower interest payments because rates have come down.
This is all going to continue. The risk is much like the debt and deficit, inflation rises much faster than the fed wants it to. Unlike 2008 where most of the stimulus ended up in the banks, today most is being directly injected into the economy. I dont know where gold will be tomorrow or next week or next month, but I do think it will be higher six months from now and the dollar will be lower.
First comment should have said the Fed released its academic paper in November 2019, not last November.
Gold luck with that reasoning. Biden will add 11 trillion to our debt this year. Something will give and it won't be gold.
It's not my reasoning. It's called economics.
so you increase the amount of paper currency, the amount of debt and a solid asset like gold is supposed to go lower ...lol
There is a fundamental argument in the market,. The dollar was sold off on the rising debt, oversupply of dollars ,and now it's strengthening on the expectation that the stimulus will kickstart the economy, spiking inflation, and along with that the Fed rate, strengthening the dollar.
As more writings about gold down trend and pressure on gold, the more it reflects gold pressuring this whole system :)
I agree with a bearish tone and gold not going anywhere too fast, this morning's critical point podcast on the podcast app,which I highly respect says stocks look good for awhile
in March writers «saw» 1930s depression, stock cheap, now you see It Up, at dangerous levels, althoug its a rational liwquidity bubble. So, real yields will determine this, plus a correction (comes when all off guard). money printing, favours gold also
Hi Jan, I've written extensively on the subject. I discuss the market narrative. For a long time stimulus caused the dollar to decline, because of rising debt and oversupply of dollars. Now, stimulus is buttressing the dollar, because of reflation. This is a fundamental argument. I am just calling it like it is, as it happens on the chart.
its fine, your inputs very valuable, I just believe all Fiats «down», real rates low, Gold ++ Up long term in Eur , Dollar relatives, anyhow, Thanks
 You're welcome and thank you.
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