Too early to buy gold and gold stocks

In Free by Cam Hui

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The stars seem to be aligning for a revival in gold prices. Prices saw a nice bounce today as equities weakened. The trends in other asset classes, such as stocks, bonds, and the US Dollar, look very stretched in the short-term and poised to reverse. From an inter-market analyst viewpoint, gold also seems to be in that camp.

The chart of gold below tells the story. Bullion prices have been falling and they are oversold on RSI-14. The violation of key support at the 1205-1210 zone has prompted high volume selling, which is indicative of investor capitulation. From a technical perspective, gold prices are now testing a Fibonacci retracement level at 1170.
 

 

This seems to be a classic setup for a revival in gold prices. Not so fast! While gold prices may stage an oversold rally here, a durable bottom may not be in place just yet.

Sentiment not washed out

There are a couple of reasons why it may be too early to buy gold for anything other than a tactical bounce. First, Mark Hulbert observed that sentiment is not washed out yet. His monitor of gold timing timers shows that they haven’t totally capitulated yet:

Consider the average recommended gold exposure level among several dozen short-term gold timers who I monitor on a daily basis (as measured by the Hulbert Gold Newsletter Sentiment Index, or HGNSI). This average currently stands at minus 18.0%, which means that the typical short-term gold timer is allocating 18% of his gold trading portfolio to going short.

To be sure, that means the typical gold timer isn’t bullish right now. And, other things being equal, you’d think that contrarians would be encouraged by this reading. But, as you can see from the accompanying chart, gold’s rallies in recent years that lasted more than a few days typically began when the HGNSI was below minus 30%.

Another bad omen for gold came in the wake of Wednesday’s big drop in the price of gold. Since the normal pattern is for bullishness to rise and fall more or less in sync with the market, we would normally have expected the HGNSI to fall Wednesday. Contrarians consider it a bad sign that the HGNSI in fact didn’t budge.

 

An examination of the amount of gold held in GLD tells a similar story. While gold prices have declined (black line), the amount of gold held (blue line) have not fallen to levels that signal a sentiment washout.
 

 

Wait for the re-test

In addition, a careful review of the % bullish metric on gold stocks shows that these stocks are oversold (bottom panel). Initial oversold readings, where % bullish has fallen below 10%, are marked with blue vertical lines. These stocks have tended to see a least a second test of the oversold lows before launching into a bull phase, where the final low are marked with red vertical lines. The current decline is only showing an “initial” oversold condition. If history is any guide, then we are likely to see a rally, followed by a re-test of the lows before GDX can launch into a sustainable bull phase.
 

 

Bottom line: Gold bullion and gold stocks may stage an oversold bounce here, but the bottoming process is incomplete. Wait for signs of further sentiment deterioration, couple with a re-test of the breadth metrics, before a bullish revival can be sustained.

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