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Minyan Mailbag: Gold and the XAU Topping?


Gold is not just a weak dollar play, the metal is rallying in all fiat currencies.


Dear Prof. Lewis,

What say you of the potential head and shoulders pattern developing in the XAU as proposed by the esteemed Prof. Harrison? In the face of what appears to be imminent Fed Rate cuts, this doesn't seem to jive with the dollar devaluation/fiat currency/store of value play.

Minyan Nick


I'm a little disappointed to see gold down again today (its 4th down day in a row), but I don't believe it's anything other than a short-term phenomenon that is the result of several near-term events coming together at the same time.

First, we have a big roll this week in the futures market from the Dec. to Feb. contracts in gold in addition to an option expiration having occurred at Tuesday's close. Second, crude has corrected and appears to have dragged on the metals this week. Third, the dollar index has had what appears to be a short covering rally over the past several days into month end.

Despite all those things and the fact that lots of new shorts have entered the market this week, the metal hasn't taken out its low of a week ago, whereas crude has. It's still a tug of war between the bulls and bears to see who can break out of what appears to be a triangle of sorts technically. The bigger fundamental news of the week for gold was the fact that the GLD ETF inhaled another 18 tonnes on Tuesday to bring its holdings to a new high of 609 tonnes, surpassing even the Chinese central bank in gold holdings. With physical investment demand like that coming in, it's going to be difficult for the bears to keep gold down for very long.

As for a Head and Shoulders top in the XAU... I suppose if one tilts their head just right and squints, it could be seen that way potentially. Although, I tend to view it more as a triangle, myself much as gold appears to be in (see the XAU chart below). As with many things, technical analysis is subjective and all in the eye of the beholder. Consequently, I find it's best to have some sort of fundamental analysis in conjunction with technical analysis in order to make an investment decision.

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In that same vein, let's return to the XAU/Gold ratio. As I've said, betting on downside in gold shares at this level in the ratio has generally been a low probability bet over the past 20 years, as you can see from the chart below.

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And keep in mind that those prior plunges in the ratio to the 0.21 area to even lower levels have occurred near major lows, not just off of all-time highs, as we are now. To have this low of an XAU/Gold ratio (basically back near the August panic lows) with the XAU, HUI, GDX all breaking out to new all-time highs for the first time in 25 years is extremely bullish from a contrarian standpoint.

Think about it this way: If the Dow were to melt up to a new all-time high at 20,000 and was trading at a mere PE of 5x and a dividend yield of 7% because the market was so terrified that the economy was about to collapse (even as stock prices went to new highs AND they were dirt cheap relative to earnings), would you want to short that? I sure wouldn't. That's a recipe for an upside explosion, and is actually what frequently happens at big bullish inflection points. In essence, we're seeing the equivalent of that in the gold shares right now.

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I would also note that this XAU/Gold ratio (see the second chart below) has actually been improving this week since hitting its low a few days ago back near the August low, and even today, the XAU is diverging from gold by not even returning to its low for the week (or even its low of two days ago) even as gold is going out a fresh new low for the week (first chart below).

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That's bullish action in the shares and suggests to me prices will resolve to the upside for the entire complex, not the downside. Keep in mind that the low for both the shares (whether the XAU, HUI, or GDX) and the metal for the pullback that began in early November is still last week's low for the time being, and some shares have actually been breaking out to the upside over the past several days even as gold has come in. For example, note AngloGold Ashanti (AU) is hitting a new 6-month high today. In fact, it wouldn't surprise me if the shares even rallied back this afternoon after the metal closes.

I'm as bullish on the gold sector now as I was back on the lows in August, and I still anticipate December is going to be a month to remember for the gold complex.

Also, keep an eye out for dollar-related news from the GCC early next week with respect to the dollar's recent bounce, I doubt it's going to be bullish. At the end of the day, all these fiat currencies are confetti, and the dollar is no doubt going to rally at some point against the euro, but December is seasonally a horrible month for the US dollar index (in other words, it's a good month for the euro). It's too early to look for a big bounce in the buck at this point in my view. In January (a good month for the US dollar index typically), that may change, but for now, I see no reason to be excited about being long the dollar with the Fed about to ease 50 to 100 bps and the US financial system virtually insolvent.

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In any event, gold is not just a weak dollar play. As I've noted before, gold is rallying in all fiat currencies. The dollar's historic breakdown against the G7 currencies is just a reflection of the breakdown in the world's monetary system. The fiat dollar based monetary system is broken after years of abuse from the Greenspan Fed, and the market is now sending a message loud and clear in the form of the dollar index at historic lows and gold just shy of an all-time high that it has lost confidence in the ability of that system to continue in its current form due to the enormous size of the imbalances that have developed.

Position in Gold, Gold Shares

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