Something Has Changed
When we wrote the last update on gold and gold stocks on May 7, the Greek election results had just been received. Another leg down in the gold price started right around that time and as usual, the decline was magnified notably in the gold stocks. However, since then, the long streak of underperformance of gold stocks against gold has markedly reversed.
At the same time, no notable changes have occurred in sentiment yet – trader sentiment on gold remains at the low end of a multi-year range, in spite of the fact that the CME has just lowered margin requirements for gold futures for the second time (likely the work of the gold bug fifth column hiding at the CME that is trying to manipulate the price upward).
To be sure, the massive sell-off in gold stocks never made much sense. Note that this is a comment that refers to objectively ascertainable facts, such as developments in gold's real price and the gold price in terms of foreign currencies. Both are as a rule more important for gold mining margins than the nominal dollar price of gold.
Meanwhile, gold priced in US dollars has built a descending triangle that most people probably interpret as a bearish chart formation. However, such triangles have been formed in previous consolidation periods as well and the outcome was as a rule not bearish on these occasions. Gold has had a tendency of consolidating gains in triangles at every degree of trend since the 1970's (even the entire bear market from 1980 to 2000 consists of a large descending triangle).
The dollar gold price and some of the notable news events that coincided with turning points - click chart for better resolution.
Gold, 1971 to January 1975 – many triangles formed during this advance. Note that several of them were descending triangles as well - click chart for better resolution.
Even during the final two years of the bear market in 1999-2000 a descending triangle was formed. Note that at the time, gold stocks also vastly underperformed gold - click chart for better resolution.
The market's recent change in character, specifically with regards to the gold stocks can be gleaned by looking at the ratio of the HUI to gold and the ratio of the HUI to the SPX:
The HUI-gold ratio has improved sharply, getting back above the near term downtrend resistance. More resistance awaits - click chart for better resolution.
After putting in a notable momentum divergence, the HUI-SPX ratio has turned up swiftly as well - click chart for better resolution.
The HUI is approaching a first level of resistance (there is lateral resistance every 20 points, at roughly 440, 460 and 480) - click chart for better resolution.
What was also noteworthy and a sign that the recent low in gold stocks may actually hold for a change (this is to say, represent a low of at least medium term significance) is the high trading volume in GDX, GDXJ, NUGT and DUST (the latter two are 3 times leveraged bull and bear ETFs on the gold mining stocks) on the days surrounding the turning point.
GDX: large trading volume near the low and during the subsequent rebound - click chart for better resolution.
The trading volume in GDXJ was even more notable. A lot of towel-throwing by worn out bulls happened at the low - click chart for better resolution.
There was record volume in NUGT around the low - click chart for better resolution.
DUST: a 'parabolic' rise, followed by a plunge on high volume - click chart for better resolution.
Gold Ratios and Gold in Foreign Currencies
As mentioned above, the sharp sell-off in gold stocks seemed to make little sense, as it happened to coincide with the prospect of better gold mining margins. Essentially the market sold the fundamentals of the past.
Although costs have risen, margins have risen more. More importantly, they seem set to increase further prospectively, as it takes a while for relative price changes to filter through to the bottom line. Consider for instance labor costs: with iron ore and other base metals prices under the pressure and the outlook for future prices clouded by growing uncertainty over the global economy, and more specifically China's economy, many expansion projects are lately being shelved (a recent example is the decision by BHP Billiton not to blindly pursue its iron ore related expansion plans). This should relax the pressure on mining labor costs and other input costs going forward.
Gold's real price as measured by the Gold-CCI ratio actually remains close to a record high - a sign that gold continues to be held aloft by market perceptions about the glum economic outlook.
Gold in euro terms – this triangle looks actually a bit stronger than that in USD terms - click chart for better resolution.
Gold in terms of the South African Rand versus two SA gold mining shares, HMY (green line behind gold price) and AU (below). A huge gap has opened up between gold in ZAR and SA gold stocks for no good reason - click chart for better resolution.
Gold versus crude oil: the current level is slightly above the long term average, so gold's price against crude is actually strong at the moment. Energy is the second most important input cost in mining after labor - click chart for better resolution.
The gold-CCI ratio compared to the HUI index (the CCI is the 'old' CRB index, in which the different commodity groups are equal-weighted). Gold is close to a record high against commodities. There was a gold stock overvaluation gap in early 2011, while there is an undervaluation gap now - click chart for better resolution.
The HUI versus GLD, long term. Since the 2008 crash, the gap between the two has continued to grow. It is probably time for things to go the other way for a while - click chart for better resolution.
The gold – silver ratio: a measure of growing, respectively declining economic confidence and an early warning indicator for credit spreads (when this ratio rises, credit spreads tend to widen with a slight lag) - click chart for better resolution.
The US dollar versus gold - a tale of two recent divergences - click chart for better resolution.
Silver versus SIL (silver stocks ETF) – at the recent low there was a 'give-up' decline in SIL as well - click chart for better resolution.
Sentiment Data
Surprisingly, not much has changed on the sentiment front just yet, although the gold timers observed by Mark Hulbert have become somewhat less bearish in the aggregate (this is probably because many of them let the action in gold mining stocks enter into their assessment of the situation).
Public opinion on gold (an amalgamation of various sentiment surveys) – still close to its recent lows - click chart for better resolution.
Mark Hulbert's HGNSI – from minus 14.8 (recommended exposure on average: 14.8% net short the sector) to just above the zero line - click chart for better resolution.
By contrast, traders have a love affair with the US dollar at present. This is one of the three highest bullish consensus readings since 2008. Will this time be different? - click chart for better resolution.
Commitments of traders in the futures of the currency everybody loves to hate: yet another new record high in the net speculative short position against the euro has been recorded. Note that there are now several bullish divergences between positioning and price data (both in the long and the short term) - click chart for better resolution.
Conclusion:
The only thing that bothers us about the otherwise much better looking picture is that everybody is aware of it. Often the things that are widely known are not of much value. On the other hand, when looking at a recent interview of fund manager John Hathaway (who is managing a gold and gold stocks fund) published at INO.com in which he voiced his belief that a low was at hand, we were struck by the fact that every single reader comment was negative (i.e., expressed bearishness).
So there is definitely a considerable number of bearish traders. This is by itself not a guarantee for anything, but combined with the better technical action in gold stocks it could prove to be meaningful.
Most likely a period of backing and filling will precede a sustained uptrend though, as the traditionally seasonally weak period is dead ahead and the technical damage is great. The chances that a durable low in the HUI index has been seen would increase if it managed to put in a higher low on a pullback followed by a run to a higher high – we caution that this has yet to happen.
Lastly, we are encouraged by a particular detail of the most recent commitments of traders report for gold futures (via snalaska.com). In particular, the ratio of non-reportable (small trader) gross long to gross short positions has fallen below 2. This has been a fairly reliable bullish short term indication in the past - click chart for better resolution.
Commitments of traders in gold futures. With 52,551 long versus 32,104 short position, the small speculator long-short ratio has fallen to 1.64, well below the (normally) bullish threshold of 2. Observe also that commercial hedgers have added to their gross long position for five weeks running, often also a positive sign – click chart for better resolution.
We hasten to add to the above that a correct interpretation of the CoT report can only be achieved in the proper context. In bear markets, the parameters for what constitutes a bullish alignment are vastly different from the yardsticks applied during bull markets.
The comments above will only make sense if a bull market is in principle still in place. However, we assume this to be the case as the fundamental backdrop for gold remains bullish at this juncture and there seems nothing on the horizon as of yet that threatens to alter this condition.
Charts by: sentimentrader, bigcharts, stockcharts.com, snalaska.com