, Investing Strategies

How low can gold go?

June 3, 2016 / by TradeSmith Research Team

I’ve been warning about a possible sharp correction in gold for weeks now. That correction has arrived. The question now is, how low can gold go? We are going to dive into the current SSI chart on cash gold.

As I write today, gold is up sharply ($30 an ounce) after a huge miss in the US jobs report. Does this mean that the bottom is already in after the recent correction?

I don’t think so. Here’s why:

Here is the current SSI chart on cash gold. Note that this is as of the Thursday, June 2 close, so it does not show today’s sharp rise.

Let me highlight a few important numbers for us in regards to the current SSI chart on cash gold:

Low close: $1,051/oz on December 17, 2015.
Recent high close: $1,295/oz on May 2, 2016
Latest close: $1,210/oz on June 2, 2016
SSI Trend line: $1,205/oz
SSI Low Risk Zone top: $1,198/oz

From the December 2015 low to the May 2016 high, gold rose 23%. The recent correction has given back about a third of those gains. The June 2, 2016 close was just a hair above the SSI Trend and two hairs above the top of the Low Risk Zone.

So, was this short correction sufficient to exhaust the overbought situation in gold and overcome the negative “smart-money” sentiment I’ve been pointing out for the past month?
Let’s take a look.

The following chart shows the activity of the commercial hedgers in the gold futures market (aka the “smart-money”). For weeks now, we’ve pointed out how they’ve been gleefully selling their gold into the recent rally.

While they have certainly started to cover some of their short positions (aka take off their hedges) during this recent dip in the price of gold, we can easily see that they are still at historically high levels of hedging. In other words, they still have a massive short position on in gold.

Additionally, it’s also apparent in the chart below that the very big overhead volume in GLD has turned prices back from the $120 level.

My personal opinion is that gold still has further to fall and that today’s spike in gold is largely a short-term short-squeeze caused by the unexpectedly weak US jobs report.

The narrative from the jobs report is that the Federal Reserve now can’t raise short-term interest rates at the June meeting … and probably not at the July meeting either. Hence low interest rates are here to stay for a while and that’s bullish for gold.

It’s a compelling narrative and I don’t necessarily disagree with it, but things are rarely that straightforward when it comes to the financial markets … especially in the short-run.

As Buffett’s mentor Ben Graham famously said, in the long run, markets act like a weighing machine that can accurately assess the substance of a company or asset. In the short-run, however, markets act like a voting machine.

The commercial hedgers in the gold market control a big chunk of the votes. They’re voting for a deeper correction in gold. I’m pretty sure that they’re enthusiastic sellers into today’s rally.

I’m still looking for gold to fall solidly into the Low Risk Zone. That would be around $1,150 for cash gold and $112 on GLD.

For the record, here are my current charts for GDX and GDXJ (the gold and junior gold miner ETFs):