Look before you leap!
The first thing that needs to be addressed with all market activity as the New Year begins is the lack of liquidity during the first week or two of January. The following graph from the CMEGroup, the world's largest futures exchange, illustrates how liquidity left the entire futures market on approximately December 15, 2023. Last year was not a rare occurrence for this event, as it repeats yearly.
Source: CMEGroup
Before December 15, the cumulative open interest (white line) at the CMEGroup was approximately 127 million contracts. The nadir in liquidity came on December 26 at 104 million contracts, Illustrating how speculators and commercial traders reduce their activity and portfolios into year-end. As of this writing, market participants who hold positions overnight have not been returning to the market significantly. The cumulative exchange volume was also the lowest on December 26 and has increased since. The increase in volume only represents an increase in day trading activity.
The point is that markets cannot move in a dominant direction without the help of large traders taking positions overnight. Traders should be skeptical of market moves until the open interest returns (participation).
Gold's catalyst for higher prices
The most significant change has probably been in the Federal Reserve (FED) Board's stance on interest rates as of December 2023. Where the FED Chairman, Powell, insinuated the FED has paused raising interest rates and iterated multiple rate cuts in 2024. This recent decision goes against the hard stance the FED has taken in the past, which was that fighting inflation was the most crucial item. With inflation still above 3% and their target rate lower at 2%, cutting rates too early almost appears to be a political move due to the 2024 general election. If the FED follows through with the rate cuts, this will weaken the US dollar, make gold more attractive, and make other commodities more expensive.
The markets ran with this announcement, pushing some stock indexes to all-time highs. Gold will benefit if the rate cuts occur because higher interest rates compete for gold purchases.
The Middle Eastern conflict continues with no foreseeable end in sight. The stability seems to be weakening with new situations arising across the region. Ukraine and Russia are no closer to an agreement, and the war continues. The market continues to monitor both situations as shipping much-needed supplies becomes difficult. Failure to deliver could return an unwanted global supply chain issue, opening the door for inflation.
As we get closer to the election primaries in the United States, more eyes will shift to the 2024 general election. The uncertainty of this election will bring nervousness to the markets.
Is gold undervalued compared to other commodities?
Commodity index funds and portfolio managers looking for value commodities may find gold a good candidate. As many as 15 commodities had double-digit percentage wins in 2023, possibly resulting in their prices being overvalued to start 2024. The February gold futures contract had a bullish year but only returned about 8% year-over-year. With the monthly trend still up and gold fundamentals bullish, we could see more money chasing the metal or the miners.
Source: Barchart
The February gold chart illustrates the 2023 return for December 2022 to the December 2023 close. With a 150.7 handle move and a 7.84% increase.
The Commitment of Traders (COT) report
We've been discussing some of the tailwinds for gold, but the late-year rally did not go unnoticed by the large speculators (green line) as they piled into their most bullish posture than at any time in the past 52 weeks. Looking to the left, in May 2023, large speculators held about 207K more longs than shorts, the same amount they currently have, and the market corrected. At the same time, the commercial traders (red line) held more shorts at the close of the year than at any time in the past 52 weeks. Patterns like this are not abnormal in bullish market environments. But, this data does show there may need to be a price correction before gold can resume its bull market.
Technicals
Source: Barchart
Technically, the weekly February gold chart shows the three-year sideways trend until finally closing outside of it in November 2023. If gold continues to hold the prior resistance, which is now support of the previous all-time high, the bulls may see the market continue to trend higher.
Seasonal Pattern
Source: Moore Research Center, Inc. (MRCI)
The February gold chart above illustrates the past 15-year seasonal pattern (blue line). The seasonal low for the February gold contract historically came in mid-December. This year, the low appears to have come early in October. MRCI has found that the move-up can become over-extended when market troughs come early due to the bullish nature of the current cycle.
Seasonal patterns are an excellent tool for scanning markets for opportunities, but it's worth noting when the seasonal pattern has the potential to rise until contract expiration.
MRCI optimal window (yellow box) shows that the February gold contract closed higher on about January 25 than on January 09 for 13 of 15 years or 87%.
The most exciting scenario of this seasonal pattern is MRCI research showing that in the past 15 years, 7 seasonal patterns did not have a daily closing drawdown. That's almost half the time!
"It's important to note that while seasonal patterns can provide valuable insights, they should not be the sole basis for trading decisions. Traders must also consider other technical and fundamental indicators, risk management strategies, and market conditions to make well-informed and balanced trading choices."
In closing
Tailwinds:
- Gold experienced a 7.8% gain last year, while other commodities experienced double-digit returns.
- If the FED pivots, the lower rates will support gold prices.
- Lower rates will pressure the US dollar lower.
- Geopolitical events are broadening, not regressing.
- The 2024 pre and post-general election could create massive market uncertainty.
Headwinds:
- Large traders have not fully returned to the markets for the New Year.
- The COT report shows an over-extended bullish large speculator group.
- Prices have broken out of a three-year trading range but immediately retraced to the breakout and have struggled to rally.
