Gold may be a ‘buy’ as investors turn ever more bearish

By Mark Hulbert

The last time such gloom set in, the yellow metal staged a rally

CHAPEL HILL, N.C. (MarketWatch) — Gold is finally getting close to a bottom in prices.

That is the surprising conclusion of contrarian analysis, which for months now has stubbornly refused to turn positive on gold — even as the yellow metal has suffered a death by a thousand cuts. Just this week, for example, bullion hit a fresh three-month low — among indications that gold’s recent decline has violated some key technical levels.

But what contrarians focus on is market sentiment, and on that front there has been a big change: For the first time in a long time, a large number of short-term gold timers have decided to throw in the towel.

As a result, the market-timing community on balance is now more bearish than it has been in 14 months — which, according to the contrary logic of contrarian analysis, is a bullish development. The last time the typical gold timer was as gloomy as he is today, gold began a two-month rally in which it gained more than $200.

Consider the average recommended gold market exposure level among a subset of short-term gold market timers tracked by the Hulbert Financial Digest (as measured by the Hulbert Gold Newsletter Sentiment Index, or HGNSI). This average currently stands at minus 40.6%, which means that the typical gold timer is recommending that clients allocate nearly half their gold-oriented portfolios to going short the market.

That’s a particularly aggressive bet that gold will keep declining, and — at least according to contrarian analysis — these timers are unlikely to be right.

As recently as last week, the HGNSI had not fallen below minus 21.9%. That was less than the lows to which this sentiment index fell last December (minus 36.7%) and in the summer of 2013 (minus 56.7%). And that, in turn, led me to conclude that contrarians were not yet ready to bet on even a short-term rally.

That’s why, in mid-July — the last time I devoted a MarketWatch column to a contrarian analysis of gold — I argued that sentiment conditions were not yet favorable for gold. “Unless you have nerves of steel and are ready and willing to hold on to gold despite extraordinary volatility,” I concluded, “you might want to wait until sentiment conditions are more favorable.” Gold at that time was trading at around $1,310 an ounce.

The usual qualifications apply, of course. Sentiment is not the only thing that moves the markets. And even when contrarian analysis is right, it doesn’t necessarily have pinpoint accuracy. But, because sentiment analysis has been on the correct side of this gold market in recent months, it’s definitely noteworthy that it’s now more optimistic.

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