Friday, March 28, 2014

Gold and Gold Stocks – A Comment on the Correction

by Pater Tenebrarum

A Bigger than Expected Downturn

The recent downturn in gold and gold stocks has become bigger than we expected. We basically thought that gold might correct to the support area around $1320 and then resume its rally to test the interim high around $1420 to 1430 that was reached last August. Clearly that has turned out to be an overoptimistic assessment.

One hint that things may turn out otherwise was probably the fact that gold stocks turned down again very shortly after making a standard upside move from a small triangle/pennant, which is usually a bullish continuation pattern. Often when bullish (or bearish) formations fail, there is a tendency for prices to overshoot in the other direction (see the GDX chart further below).

From a fundamental point of view, it was perhaps an unfortunate coincidence that the loss of the 'Ukraine premium' happened so shortly before the latest 'taper scare', whereby the biggest problem about the latter was apparently the fact that Ms. Yellen announced a time plan for the Fed's eventual hiking of interest rates. Of course, such a time plan is nonsense anyway. No-one knows what monetary policy will be more than a year from now, least of all the bureaucrats running the Fed.

Let us not forget that their policy is a rule reactive, i.e., they are like someone driving a car forward while gazing intently out of the rear window all the time. As we have pointed out on occasion of the most recent FOMC announcement: bureaucrats are as a rule not the best economic forecasters. If they were actually good at this kind of thing, they would be running a business, not a bureaucracy. In fact, if one looks at the transcriptions of their meetings, which we hoi-polloi for unfathomable reasons only get to see with a 6 year delay, then the one thing that stands out like a sore thumb is how utterly clueless they often seem to be. Mind, this is not something new. If one looks at transcripts from as far back as the 1930s one will find that they were just as clueless then as they are now. It is apparently in the nature of the job. Of course this does give one pause. One wonders why anyone would think it a good idea to give these people price fixing powers allowing them to manipulate one of the most important signals actors in the economy employ for the purposes of calculation and coordination.

However, that is neither here nor there – the important point we want to make is only this: gold market participants evidently got cold feet over what seemingly amounted to guidance about the presumed coming tightening of monetary policy. However, this reaction made just as little sense as announcing the rate hike time plan did. Market participants should know how meaningless such statements are.

However, it still is the best explanation for what triggered the recent move in the gold price. Basically the news served as an excuse to take profits, and then the move acquired a bit of a life of its own, as numerous stops were triggered on the way down. By now, gold has retraced almost exactly 50% of the preceding rally:


Gold, daily – landing at the 50% retracement level (for now). Oversold, but it could of course get more so – click to enlarge.

Not to belabor the obvious too much, previous downturns of similar speed and extent have tended to go quite a bit further (sometimes after intermittent bounces). If this one doesn't, it will represent a change in character. One can of course rule nothing out – including, as some observers believe, that a drop to a new low will occur as a kind of 'final shake-out', but this is just guesswork at this juncture.

Interestingly, on Thursday, a divergence between gold and gold stocks developed. While the metal dropped by $14 on the day (from one COMEX close to the next), GDX and the gold stock indexes actually ended the day in positive territory. The gold juniors ETF GDXJ rose even by a not too shabby 3.5%.

Below is a chart showing the intraday action in GLD and GDX over the past 5 trading days, followed by a chart zooming in on Thursday's action.


GLD, 5 minute candles over the past 5 trading days. GDX is the black line above. The blue dotted lines show the level of Wednesday's close – click to enlarge.


GDX and GLD, line charts zooming on Thursday's trading. In the final hour of trading the divergence began to take shape – click to enlarge.

Will this divergence prove meaningful? We don't know yet of course, but it might well. Gold stocks have interestingly also precisely hit a Fibonacci retracement level on Thursday.

Gold Stocks Hit 61.8% Retracement

There is nothing magical about Fibonnaci retracements of course, but sometimes it is uncanny how they seem to come into play. For instance, while gold itself hit the 50% level almost on the dot, the gold stocks managed to touch the 61.8% retracement level on the dot on the same day. Just below that level is another lateral support line defined by two previous lows. Needless to say, any decline beyond these levels will likely lead to a test of the previous lows at a minimum, so it seems rather important that they hold:


The HUI, daily – a reversal after hitting the 61.8% retracement level – click to enlarge.

Incidentally this action has also filled a chart gap that was created on occasion of the rally out of the congestion zone of late January/early February. So the gaps do all still get filled after all.

GDX has bounced off the 61.8% retracement level of the rally from the December low as well. The GDX chart is below – we have annotated the failed rally out of the triangle discussed above. The recent pullback has of course  also pushed the RSI below the 50 level, which is a slight negative.


GDX – also bouncing off the 61.8% retracement level. The quick reversal of the rally out of the triangle has proved to be a warning sign – click to enlarge.

Sentiment Data

We keep an eye on unusual options activity every day.  Gold stocks rarely show up in the list of stocks with notable options volume, but when one of them does, we have found it often means a short term trend change is imminent (in fact, it seems that it is a straightforward contrary indicator: heavy put volume is seen shortly before rallies, heavy call volume shortly before declines). Note that it is usually only a single stock that displays noteworthy action, in rare cases there may be two. On Thursday, there was enough buying of GFI puts for the activity to become noticeable. Interestingly, the stock almost immediately began to rally thereafter (and with it, the rest of the sector).

Other sentiment data show that the recent slight improvement in bullish sentiment has neither gone very far, nor could it be maintained at what were historically modest levels to begin with. In other words, skepticism remains high. Potentially this could lend quite a bit of support should the rally resume (it is not the skepticism as such that provides the support, it is the prospective unwinding of negative sentiment).

First a look at the Rydex precious metals fund. Both its asset value and net cumulative cash flows have turned down again, but a little cash actually flowed in yesterday:

Rydex pm fund

Rydex precious metals fund. The cumulative net cash flow bounces on Thursday after declining over the past two weeks or so. (interestingly if bounced from what looks like a 'support trend line'!) - click to enlarge.

Next a look at sentimentrader's 'public opinion' chart of gold, which is an average of the most important sentiment surveys – the current level of 45 is not exactly reflecting a surfeit of bullish excitement:

gold, public opinion
Gold, public opinion – at 45% bulls, this indicator is at a level that was considered low during the bull market. Compared to more recent readings it is sort of mid-range – click to enlarge.

And finally, a chart showing the discount to NAV of the closed-end bullion fund GTU. The fund has traded at a discount for quite some time, reflecting persistent bearishness. It remains at a discount, but the recent slight tendency toward improvement hasn't been eradicated entirely yet:


GTU's discount to NAV has increased again, but not to the extreme levels seen in October to December (the November low was a record) – click to enlarge.

In short, there is still no great enthusiasm for gold or gold stocks and sentiment has actually never really gotten off the mat in the first place. Obviously, for a bull market to take hold, sentiment must at some point begin to improve along with price action, so this is only a latent positive.


There is a certain chance that reaching important Fibonacci retracement levels combined with a positive divergence between gold and gold stocks on Thursday may suffice to end at least the current phase of the correction.

It is actually not unusual for initial rally attempts to fall prey to a sharp correction, but there is no way of reliably distinguishing a routine pullback from a new leg down in an ongoing bear market. Considering the many positive divergences that were recorded at last year's lows, one should probably still give the sector the benefit of the doubt at this point.

Presumably the near term action will be driven by upcoming economic data again – both ISM and payrolls data are coming next week, and they have regularly impelled moves in gold. They have tended to be bad news for gold more often then not over the past two years, as better data automatically tend to be associated with fears about tightening by the Fed.

We should also mention here that the overall fundamental backdrop for gold remains at best mixed at the moment – it is certainly not overly bearish, but also not overly bullish. However, that is not necessarily inconsistent with the  early stage of a new cyclical bull market. It will be important though that this backdrop begins to shift to a more clearly bullish one as time passes.

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