Ratio Poised to Break to the Upside?
I have focused much of my time on the gold market recently because of the significance of the May breakout above $1365/oz, which had acted as key resistance for six years, and what the breakout is communicating about the forward trajectory of global markets. Gold is a risk-off asset; a flight to safety. Its tight correlation recently to the bond market reinforces how investors have been positioning away from risk assets.
The fear throughout the summer has been that a frothy equity market (up double digits YTD), a Federal Reserve that has been reluctant to aggressively lower rates, trade wars with China and other countries, an inverted yield curve, and the cusp of a Presidential election would all serve to dampen the economic outlook and give way to recession by the fall. Energy, base metals, and emerging markets have all underperformed throughout the summer as a result of these fears, while bonds and gold have skyrocketed to multi-year highs.
This appears to be shifting, at least in the short to intermediate term. Gold and the bond market have pulled back hard from their highs last week, while oil continues to grind higher (up $8 from its recent lows). One of my favorite visualizations of this sector rotation is a chart I create pricing 100 barrels of oil in gold terms (above). The chart depicts relative value, and offers an indication of potential changes in investor sentiment.
The chart above is a 20-year weekly chart. (Normally I would use a logarithmic chart, but in the absence of trading software that can produce this chart, I am using arithmetic calculations.)
Of particular note is the consistency of the price action within specified trading channels. The horizontal support line (red) and the rising support line (black) on which this ratio is presently perched serves as a cluster of support. As long as the red line holds, I would expect a long oil, short gold pair trade to perform well as gold pulls back and oil pushes back towards $60+. I’d look to revisit my positioning if horizontal support fails or the ratio tests falling resistance from the 2008 peak. Should the ratio break out from there, the next obvious test would be rising resistance of the blue channel.