Signs Are Pointing to Gold Rally

 | Jul 14, 2017 | 2:00 PM EDT
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(This commentary originally appeared on Real Money Pro at 1 p.m. ET today. Click here to learn about this dynamic market information service for active traders.)

Gold traders must be frustrated. The fundamental premise assumed by gold bugs is a weaker U.S. dollar will be supportive for gold. The correlation dates back to the days in which the U.S. currency was backed by the yellow metal but has generally held steadfast over time despite the dollar's currently floating valuation.

Yet since the March peak in the greenback, gold and the dollar have been moving lower in tandem. In fact, the positive correlation has been running about 50% over the previous 30 trading sessions. In other words, gold and the dollar have settled in the same direction about half the time. This is in stark contrast to the historical norm of settlement in opposite directions.

This might not seem like much, but if you have been long gold supposing the weak dollar would benefit your position as it almost always does, you've been sorely mistaken. Adding to the frustration, in late 2016 the negative correlation between gold and the dollar was in full bloom; gold bugs suffered at the hands of a tremendous dollar rally, but have yet to materially benefit from the dollar's failure in early 2017.

Gold-Dollar Futures Correlation

At some point, the correlation will likely revert back to a more normal negative correlation. When it does, either the dollar will need to rally to align with gold or gold will need to rally to align with the dollar; or a little bit of both. For now, we will focus on the gold market.

According to seasonal tendencies, the price of gold generally trades neutral to positive throughout July and August but typically trades sharply higher in the fall. Further, the Commodity Futures Trading Commission's COT (Commitments of Traders) report has revealed that large speculators (smart money?) are holding less than 100,000 net-long contracts. This is among the least bullish this group has been in years; ironically, when large speculators have held small net-long positions, the gold market has found a way to rally. We suspect that will be the case this time around as well. In short, both seasonal and COT stats are pointing higher overall for the precious metal.

Looking at the chart, the August gold futures contract has bounced nicely from the $1,205 area and is approaching upside resistance near $1,248. Also, technical oscillators such as the RSI and Williams %R have turned higher. Thus, we suspect a break above $1,248 resistance will force prices toward $1,290.

Gold Futures Technical Analysis

If $1,248-ish resistance fails the first time, conservative bulls might get another chance to establish positions on a dip to support. The chart suggests $1,205 should be considered a nibble area with a possible plunge to $1,190 being a place to get more aggressive. In any case, the path of least resistance appears to be higher overall.

If you must chase prices higher from the current levels, be sure to give the trade plenty of room for error by implementing a hefty hedge or only getting long in a small increment.

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