The USD's three-week rally has extended the mighty dollar to a high since late March on the back of some hawkish FOMC minutes last week. Investors immediately repriced interest rate hike bets for June from 5 percent to 32 percent.

I think the actual game there is resetting the table for July after the potential Brexit vote. A "stay" vote from the Brits will likely make a July hike a sure thing, but we have another month to go on that.

Gold has actually held up fairly well so far on a relative basis, but the pressure is mounting, especially as we have now broken and held the 50 DMA to the downside ($1,250-ish). Both the DXY rally and the 100 DMA are setting up a test for $1,213 level, but have some prior low support at $1,230 from a month ago.

If USDJPY breaks 110 and EUR gives up the 1.11 level, we could see a broad asset repricing. Friday's second try at Q1 GDP (est. 90 bps annualized) is my only Tier 1 item on the calendar this week, and I think it is being overshadowed by the Brexit discussions and other currency movers.

Bull Case

  • ETFs continue to add ounces almost every day like clockwork. Has the distinct feel of a large institutional buyer putting on a macro long. Averaging over 100K per day toz for the month.
  • Global negative nominal yields remain and show no sign of going away, though weighted average global yield has ticked up from 1.51 to almost 1.59.
  • Geopolitical risks abound: Brexit, U.S. election, OPEC inaction and Russian restlessness top my list.
  • China slowdown is real and will likely not reverse course as Chinese credit growth versus GDP is unsustainable.
  • Central banks will likely continue to diversify away from USD holdings in favor of gold and others. Trade balances will only further aid this.
  • While we discount any probability of a major equity correction (too much insurance already purchased), corporate earnings have zero growth and are slightly negative. Little expected yield there.
  • EFP has moderated some. See also: The June-August roll has been trading around $3.30 contango for a few days. This negative carry (-1.6 percent annualized) for futures longs may have several reconsidering length.
  • Vols, skew and flys have all moderated a bit. Perhaps some of the macro options length from January took profits already?

Bear Case

  • Perhaps more indicative of over length, OTC swap rates and futures contango remain incredibly, perhaps unsustainably steep. The 3m gold swap (70 bps) hasn't been at this much of a premium to 1yr USTs since the 2013 peak.
  • Employment situation remains strong, and early hints of wage inflation continue. This is the only thing that would truly force the FOMC's hand.
  • Taylor rule and other good indicators show hiking cycle to turn more aggressive in the coming months.
  • Underlying indicators like lumber and home prices are indicative of some economic strength.
  • DXY rally could have some real legs, especially if all the Fed speakers this week turn out net hawkish v. expectations.
  • CFTC positioning (hedge statement in Chart 1, below) is still at extremes.
  • It makes me nervous to see nearly every bank on the street flip their consensus view higher and embrace stronger gold. Few shorts remain, and put skew is still nonexistent to even ATM.
  • Anecdotally, the macro tone seems to be less about fear all of the sudden. I've seen some reasonable defenses for moderation on heretofore hand-wringing topics like U.S. national debt and student loans.

Chart 1

CFTC adjusted for dollars. I can't claim originality on this concept, but this is the CFTC positioning chart adjusted for cash values instead of pure ounces. While the true view of overextension probably lies somewhere in between, most asset allocators don't view gold investments so much as numbers of ounces as much as dollars.

A large West Coast credit fund, for example, would be much more likely to buy $10 MM worth of gold rather than 8K troy ounces. With that in mind, the white, shaded line is indicative of the cash value of speculators in metal, which shows a less extreme positioning as compared to the ounces-only metric (yellow line). It is of course, very extended by this metric as well, but not yet near the record from 2011 and in fact would have another 40 percent or so to go before threatening.

To show the relative small size of the gold trade, that is $28.2B in specs v. record highs of $46B. And while $18B sounds like a bunch, it is less than 20 bps of the $10 trillion worth of global sovereign bonds now trading with negative yields. That's a small shift in asset allocation for a huge shift in metals prices.

Chart 2

Gold (candles) v. DXY (yellow, inverted, LHS). The correlation between the DXY and gold was incredibly strong through April, but has lessened some to 65 percent on gold's outperformance. We continue to watch USDJPY intraday for indication/confirmation.

Coin Toss

While we may have some room for further upside (similar to after last year's single-hike relief-rally), the prospect of Brexit and a July hike have brought renewed strength to the U.S. dollar and treasury yields. Those markets are so much bigger that I have a difficult time arguing that we will stem the tide.

If we close again below $1,250 and even worse, $1,213, the CTAs will switch to net sellers. We've been bearish for some time, and those reasons remain, but there are some good tests to our thesis ahead: lower.