A Rate Cut, Gold & Stocks…It’s 2008 All Over Again?

Gold seems to have reacted not as much to the rate cut itself, but to the surprise…

by Przemysław Radomski via Sunshine Profits

It was only yesterday (and Monday), when we emphasized that it seems that it’s 2008 all over again, and that the interest rate cuts as well as possibility of QE4 are not likely to prevent markets from declining. The next regular interest rate decision is on March 18, but the Fed decided to cut the rates by 0.5% yesterday in a surprising move. And… stocks declined (and we profited both on their move higher in anticipation of that cut, and also on the intraday decline in its aftermath in our Stock Trading Alerts), just like they did in 2008, when the rates were cut.

And gold?

Yes, a rate cut, as a response to the coronavirus threat, is a theoretically bullish development, as it’s positive for the economy in the short run, but it seems that the market viewed this decision as an act of desperation, and a confirmation that things might be much worse than they are being reported. This is a very dangerous kind of reaction, because the fact that the market declined, only reinforced the belief that the Fed can’t stop a move down with lower rates. At least not before the market declines a lot.

Markets are forward-looking, which means that if people expect lower prices, they will sell right away, at prices that they still view as relatively high. It really does look like the 2008 decline.

So why did gold rally so much, yesterday? Doesn’t that invalidate the analogy to 2008?

First of all, did gold really show a lot of bullishness yesterday? The rates were just cut by 0.5% in a surprising move, and gold is not at new highs, while miners reversed a large part of their gains before the closing bell.

Second, a single day event rarely invalidates or confirms anything. Quick moves can be accidental, or based on extremely short-term trends that are predicted using other means.

Third, it was not just a decrease in the interest rates. It was a surprising decrease in the interest rates. Gold, and the rest of the precious metals sector seems to have reacted not as much to the rates themselves, but to the surprise. Investors looked for safe haven, and they found it in gold. But, just as such rallies didn’t last long in 2008, they are unlikely to last for long this year.

The Fedwatch tool didn’t update yet after yesterday’s decision from the Fed, which means that we don’t know what kind of probabilities the market is assigning to further rate cuts this month (and how big they are likely to be).

However, we know that since the Fed cut the rates and surprised the market now, it has one fewer surprise-ace up its sleeve. This suggests that as the prices decline, it will take longer time, before another surprising move takes place (note: it’s just likely that it works this way, it’s far from certain – the Fed could have so many surprise-aces up its sleeve that using one now doesn’t change much). This means that perhaps one of the corrective upswings that was supposed to happen in the future, has already happened in a surprising manner yesterday, and the decline that follows is likely to move lower in straighter fashion.

Yesterday’s PMs Moves Examined

Gold corrected about 61.8% of the preceding decline.

Gold stocks corrected about 61.8% of the preceding decline, but ended the day at the 50% Fibonacci retracement.

Silver initially corrected a bit above 38.2% of the preceding decline, but wasn’t able to hold this level, and ended the day visibly below this retracement.

These are all classic levels to which prices can retrace (correct) during a move without changing the trend. We saw the most strength in gold, and the least in silver, which is business-as-usual – that’s what’s been taking place in the previous days as well.

The point is that nothing particularly exceptional happened. Yes, the volatility was big, but it was in tune with what we saw previously. Volatile declines could be corrected with volatile rallies. And they can then be followed by additional volatile declines. Predicting that gold ended its decline just because we saw a 61.8% correction (and smaller moves in miners and silver) is likely a mistake.

Another indication that the upswing was a relatively normal part of the bigger decline comes from the GDX ETF.

The mid-2016 decline started from very similar levels, and after GDX dropped to about $25, it rallied approximately to its 50-day moving average, which was at about $28 at that time. Approximately the same thing took place today. The GDX jumped from about $25 to its 50-day moving average (GDX closed at it yesterday) and it was relatively close to $28. Back in 2016, the decline then resumed after a few weeks of sideways trading. The volatility is bigger this time, so we might not have to wait that long before the decline returns and miners move to new yearly lows.

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Thank you.

Przemyslaw Radomski, CFA
Editor-in-chief, Gold & Silver Fund Manager