Approaching the ‘Point of Control’

Wednesday, 26 May 2020
Melbourne, Australia
By Greg Canavan

On Friday, Pivot Trader Editor Murray Dawes and I had a chat with Woody about when the market might turn down again. If you missed it, you can check it out here.

The answer, according to the market this week, is ‘not yet’.

It’s not done confusing, confounding, and embarrassing enough people. Including me.

I mentioned one of the key things I am looking at to provide clues on the market is the Aussie dollar. It’s a great barometer of global risk appetite.

I mentioned in the video I wanted to see the AUD break above 67 US cents before getting more comfortable about this global stock market rally. It’s getting close though. As I type, it’s trading around 66.4 US cents.

Will it break through 67 US cents?

Let’s have a look at the chart below for clues…

The Insider

Source: Optuma

It shows the exchange rate after last night’s US market action. Note the slight divergence between price and momentum? The upswing is still in effect, so this may not be a valid signal. But if it holds, it’s worth taking note of. Divergences often signal when a price rise has run out of steam.

So that’s something I’m watching closely.

More broadly though, the market remains resilient. The ASX 200 opened down sharply today but has since rallied sharply. It’s up nearly 1% in afternoon trade…just under the 50% retracement level of the March crash…or Murray’s ‘point of control’ (see chart below).

The Insider

Source: Optuma

In fact, I was speaking to Murray on the phone earlier. We discussed how it looks like money is moving out resources and into the banks.

That makes sense given how badly beaten up the banks are.

Perhaps the market is finally realising the golden goose for resources (China) is just about cooked.

I cover the China issue in-depth today for readers of my Crisis & Opportunity letter. In short, it’s not looking good for the Middle Kingdom.

I mentioned a few weeks ago in these pages how the China growth card was a risk for the resource sector…

If China is indeed susceptible in a post-COVID world (and you would think it is, given its aggressive response to Australia’s call for an investigation), then a devaluation of the yuan may be on the cards.

That would be bearish for the global economy…and for stock markets.

It would be particularly bearish for Australia, given our reliance on China for export income. 

Our overall market has been hit hard thanks to a big fall in the banks. But the resource sector has outperformed the banks on the back of China’s ‘resilience’.

Just how much longer we can rely on China is shaping up as one of the key questions for 2020.

Is this rotation out of resources just starting?

If I’m right about China, then yes, I think it is.

***

I received a question from a reader, David, on gold this week.

Greg, just looking for your insight on gold at the moment…..it looks a bit weaker on US dollar strength….. how are you reading the paradox of gold relative to other markets…..i.e. is it a buy and hold or do you think we will see lower prices in the short term. I am having difficulty reading Hong Kong at the moment as we could see a proportionate flight of capital into Australia and effect of the $A gold price if we saw the $A back with a 7 in front of it.’

Gold is a tricky one here.

Everything looks good longer term: The charts are all in uptrends, the fundamental story remains solid…

But short term we may be readying for a pause.

Let’s have a look at the US dollar gold price first.

I mentioned divergences before. As you can see below, a decent one has played out in gold over the past few months. Prices keep rising as momentum (the relative strength index, or RSI) slows. This suggests we’ve seen a short-term top.

The Insider

Source: Optuma

My guess is that gold will correct and move sideways for sometime.

It’s had a big move since the start of the year. It makes sense that a period of correction and consolidation would result. If that were the case, it would be a good time to add to your gold holdings if you wanted to top up.

It also makes sense if you think the market bottomed in March (as I do) and that we’re in the early stages of a recovery from the government imposed lockdown. In this case, there is less need for ‘insurance’ in the form of gold.

By the way, just because I think the market bottomed in March, doesn’t mean we can’t have a decent correction in the short term. A good shake out would be healthy. Doesn’t mean we’ll get it though…

Getting back to gold, let’s look at it in Aussie dollars…

It’s a similar situation to the US dollar gold price. That is, a divergence between price and momentum.

The Insider

Source: Optuma

Again, I would expect to see gold correct over the next few months. Perhaps down to the $2,300 an ounce region. But this would be a healthy move and should be seen as an opportunity to add, rather than panic and get out.

The depth of any correction really depends on what happens to the Aussie dollar. If the AUD breaks above 67 US cents and keeps heading higher, the correction will be deeper than if it stays below 67 US cents. So there are a few moving parts here.

The other factor keeping a lid on gold prices right now, as David alludes to in his question, is gold’s relative value. For example, relative to oil, gold is more expensive than ever.

As for Hong Kong, it probably requires an essay by itself. While capital flight could of course push the AUD higher, my guess is that more capital would seek out the greenback. In addition, there is a risk that Trump will respond to China’s move on Hong Kong. This will reignite trade war fears and be bearish for the Aussie dollar.

In short, there are so many cross-currents right now it’s folly to lock yourself into any particular narrative.

Stay flexible. Keep an open mind.

Cheers,
Greg