Monday, July 15, 2013

Gold Stocks: Gap Spotting

by Pater Tenebrarum

Another Island in the HUI

The heroin junkies in Scotland are trainspotting, the gold bugs in the US are gap-spotting. Ever since the HUI began its decline, it has increasingly looked like the gap-toothed grin of a 125 year old Caucasian nomad shepherd (they get so old because they drink kefir every day, but there is a lack of dental prostheses in those craggy mountains. Contrary to the HUI, they go both up and down, not only down).

The recent rebound in the gold price has been far more spirited than the bear flag it built last time around between $1,350 and $1,400, but unfortunately the  HUI has not behaved any differently. In fact, there are many parallels so far.  Let's look at the gold price first:


The recent rebound in gold had more pizzazz than the bear flag it built from mid-May to early June – click to enlarge.

On both the occasions marked above, the HUI rebounded and left an 'island' behind in the process – this is to say, it first gapped down, then meandered around a bit, and then gapped up. Normally such behavior would be regarded as bullish, if not for the problem that it wasn't last time around.

Let us look at a daily chart of the HUI next. The problem from a technical perspective as we see it, is that previous large gaps down represent strong resistance levels. Therefore, in order for the market's character to actually change, we think it will be necessary for the index to finally conquer one of these gaps on the way up.

Hui, daily annot

The two HUI rebounds corresponding to the rebounds in gold circled above both included the formation of islands. Previous large down-gaps have proved to be insurmountable resistance so far – click to enlarge.

The question whether the most recent island will be more meaningful than the last one should soon be answered. So far, it all looks a bit lame – presumably because the market is expecting the usual earnings-related sell-off. On the other hand, not too many of those sell-offs can occur anymore before many gold stocks hit the strongest support level there is (namely, zero). Just kidding of course – in reality, when stocks go down, the process is a bit reminiscent of Zeno's race course paradox. If a stock's price gets cut in half, it can get cut in half again…and again…and again – as infinitum. There is no limit beyond the minimum prices demanded by listing requirements, and those can always be restored by means of reverse splits. We are not saying that this is in store by the way, just noting that it is possible in principle. For a slightly scary example of what can happen, look at certain coal stocks like ACI or ANR. ACI traded at $76 at its 2008 high – recently it could be bought for $3.49. That means it fell by 90% and then fell by another 55% from there, for good measure. But then again, it is a coal stock and not a gold stock.

Here is a close-up of the recent HUI island:


The HUI over the past ten trading days. So far the gap that separates the island from the trading since then has provided support. The next major resistance zone (the previous gap down) begins at about 238 points – click to enlarge.


Even though we obviously cannot know when or from what level a sustainable reversal will take place, it can be stated that the market's character has not changed yet. It can also be stated based on the HUI's behavior to date that a change in character will have taken place once a downside gap fails to provide resistance and is overcome. So this is one of the things short term oriented traders should look for, especially as one impoortant technical ingredient for a reversal is already in place, namely a divergence between prices and momentum oscillators like RSI and MACD.

An additional point worth making: if the current bear market indeed corresponds to the 1974-1976 mid cycle correction, note that gold stocks were still 50% below their 1974 peak when gold returned to its level of late 1974 in 1978. Gold then rose much further into early 1980, but gold stocks only managed to reach the same level they had already attained in 1974. They were very volatile along the way, so 'trading around' oversold and overbought situations was a good strategy at the time. Ironically, gold stocks then rallied hugely after gold had reached its top – when it rose into its secondary peak between April and September 1980, they rallied to about twice their level of January 1980 (a brief summary of the events with charts can be found here). The market had finally become convinced that higher gold prices were here to stay when it was all over. This fits well with our previously stated thesis that the market usually 'knows' absolutely nothing, especially near major turning points.

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