Rally Still Widely Doubted

Zerohedge recently published a year-to-date performance chart of different market sectors. The gold juniors ETF GDXJ tops the list with a rally of roughly 13% this year. The Nasdaq Biotech Index is in second place, closely followed by the XAU (Philadelphia Gold & Silver Index) in third place. Only ten out of 54 sectors have exhibited a positive performance so far this year.



GDXJ vs. SPXGDXJ – the ETF representing gold juniors vs. the SPX (blue line). We noted earlier this year that we expected the gold sector to remain negatively correlated with the broader stock market, and so far that has indeed been the case – click to enlarge.



However, this credible performance has failed to impress mainstream observers, possibly because gold itself hasn't done all that much so far (although it is at the time of writing still up about $65 from its late December low). It is still not possible to find any gold bulls in the mainstream financial press. A smattering of headlines from late last week:

While gold has rallied, strategists at ETF event aren’t impressed

Why gold lost its lustre for investors

Gold rallies won't sustain without more China, India buying: Clyde Russell

The last one is especially noteworthy for its misguided assumptions. Not only is there no sign whatsoever that demand from these regions is faltering, it is not relevant to the gold price in the first place. If it were, the gold price would have risen last year instead of falling. We actually wish we had a cent for every article published over the past year in which China's gold imports or falling COMEX inventories or other irrelevant data points were hailed as bullish for gold. China has imported a net 1,150 tons last year via Hong Kong. That represents approximately 0.66 of the total global supply of gold (keep in mind that all the gold ever mined still exists above ground). Even if one assumes that only about half of the total supply is effectively available for trading purposes, we are talking about a mere 1.3% of the total available supply. In fact, the amount imported into China via Hong Kong over the entire year is equal to the amount traded in London alone approximately every 1.5 days. To see why such data are essentially meaningless to the gold price, consider Robert Blumen's article “What Determines the Price of Gold”.

The annual additions to the world's gold supply from mining and scrap and the annual demand for jewelry, coins, bars and industrial applications simply pale relative to the influence reservation demand has on the gold price. This is a direct result of gold's extremely high stock to flows ratio (the existing stock of gold only grows by about 1.4% per year, which is one of several reasons why gold is a superior form of money). It is therefore impossible to come to any valid conclusions about gold demand or the price trend by watching things like imports into China. In order to forecast future gold prices, one must proceed indirectly by attempting to forecast the fundamental factors that have the greatest influence on reservation demand (a list of these factors can be found here).

To come back to the current sentiment situation, the anecdotal evidence reflected in articles in the financial press continues to be confirmed by sentiment surveys among newsletter writers and traders. Sentimentrader's 'public opinion' chart is an average of the most important such surveys and shows that the bullish consensus remains near a multi-year low:



Gold public opinion

Public opinion on gold – bulls remain on the endangered species list – click to enlarge.



Recent Developments

The doubters of course do have a point: gold has yet to overcome significant technical resistance levels. Until that happens, improvements in the sector's performance remain susceptible to a reversal of fortunes. Note in this context that the fundamental drivers of gold mentioned above are not unequivocally bullish at the moment. At best they are neutral, but we expect them to become increasingly bullish as the year progresses (for a brief assessment of the fundamental drivers see the concluding paragraph). The question is when and from what level the gold price will begin to discount this expected change (in addition, our expectations could of course turn out to be wrong). With regard to the gold sector, gold stocks were subject to a lot of tax loss selling pressure late last year, some of which was undoubtedly reversed in January. Unfortunately there is no way for us to quantify this effect.



Gold, dailyGold daily (February contract) – resistance between $1,270 to 1,280 still needs to be overcome – click to enlarge.



In spite of the fact that we cannot determine with any certainty how big the effect from the reversal of tax loss sales was on the gold sector, the technical action in gold stocks provides a reason to remain cautiously optimistic. There have been several attempts by the HUI index to overcome the 50 day moving average over the past few months. In most instances it reversed back below it very quickly. This time there has once again been a pause after getting above the 50 day ma, but the index has not only held up well in spite of gold being a bit wobbly, but is consolidating in a triangle – and triangles have a fairly high probability of turning into continuation formations. In addition, the HUI gold ratio has held above an important support level and various price/momentum divergences were recorded at the December lows.



HUI-daily, STThe HUI tries to break above its 50 day ma for the fifth time since July. Note the triangle that has recently formed as well as the price/momentum divergences established at the lows – click to enlarge.



HUI-gold ratioHUI-gold ratio so far still holding above what looks like an important support level – click to enlarge.



The GDM bullish percent index (a measure of the percentage of index component stocks currently on a point & figure buy signal) has produced another divergence with prices at the December low by not declining to zero again as it has done on several previous occasions. This shows that the decline into the late December low was not as broad-based as previous down legs:



BPGDMThe GDM bullish percent index compared to the HUI – click to enlarge.



The ratio of the HUI to the SPX has also risen strongly this year, but its roughly 18% increase from the lows is still little more than a blip on a long term chart:



HUI-SPX STThe HUI-SPX ratio (black line), the HUI (green line) and the SPX (red line) – click to enlarge.



To provide some perspective on this ratio, here is a very long term chart of the HUI-SPX ratio. As can be seen, at the recent lows it was at its most oversold in at least 14 years if we consider both RSI and MACD:



HUI-SPX LTHUI-SPX ratio since 1999: in 2013, extremely oversold readings were recorded – click to enlarge.



What is also remarkable about this ratio chart is that the gold sector, in spite of just having suffered through one of its seven worst bear markets since 1938, is still up 4.8 times relative to the SPX since November 2000 (the ratio stood at 0.0254 in 2000 vs. 0.122 currently).


Long Term Elliott Wave Counts

The following must be taken with a big grain of salt. We have previously discussed these wave count possibilities, which are based on the idea that the secular bull market in gold is not yet over, but is instead immersed in a mid cycle correction. Whether or not this correction is over remains to be seen of course. We currently assume it is, but what we believe doesn't matter –  one must remain open minded on that point. For instance, in the 1974-1976 mid cycle correction, gold fell by 47% (from $200 to $106). A similar decline from the late August 2011 high would target the $1,000 level (or more likely, $1,030-1,040, where lateral support is provided by the March 2008 high). However, even an additional decline to this level would not necessarily invalidate the view presented below. It would only mean that wave C of II is becoming a bit larger.



Gold-LT wave countLong term wave count of gold. The problem is that even if it is conceptually correct, wave II could become bigger and/or more complex – click to enlarge.



As can be seen, we have chosen to label the 1999 advance as wave 1. This is debatable, as it is possible that the final wave down of the bear market (labeled as 2 above) was a truncated wave. However, even if one were to slightly alter the wave count by moving the beginning of the bull market to 2001, it would not change the big picture much (we could still be quite confident that the end of 3 as well as waves 4 and 5 are labeled correctly). The biggest problem is of course that we cannot be as confident regarding the extent, duration and final shape of primary wave II. It is possible that it has ended at the June or December low, but a deeper, longer-lasting and/or more complex corrective formation may eventually emerge.

Th HUI's long term wave count looks a lot different. This is because it made a lower low in November of 2000, so wave 1 can only begin at that point. Moreover, the advance from the 2008 crash low simply does not count well as an impulse wave. It seems far more likely that everything that has happened since the 2008 high is actually part of a large scale correction. In this case it is also possible that the details of the labeling of the primary impulse wave from 2000 to 2008 is not entirely correct, but once again it would not change the bigger picture if a few of the wave positions were slightly altered.



HUI-long term wave countLong term wave count of the HUI. One reason why the 2008-2013 period is likely a large corrective formation is that by contrast to the wave shapes established in the 2000-2008 advance, the rally that started in 2008 does not have a similarly clear impulsive look (the advance of the S&P index from 2009 incidentally has a similar problem) – click to enlarge.



Due to the far greater size and duration of the correction compared to that in gold, it is easier to make the case that it is over or close to being over.  One would assume though that in the event of gold declining further, wave C would still have some way to go (possibly to the vicinity of the wave A low). Naturally, once the short to medium term trend changes, the long term trend will take care of itself. As soon as a rally is in train, we will be able to tell whether these long term templates actually make sense. If it turns out that they do, they can be helpful in navigating the rally.



In the near term, gold continues to face headwinds, as inflation expectations are low (which raises real interest rates), confidence in central banks remains high, credit spreads are low, savings rates are declining and money supply growth is slowing down. Many of these factors are likely to change in gold's favor as the year progresses, but it hasn't happened yet (or not to a sufficient degree). The yield curve has become a tad more gold-friendly last year, and the US dollar seems largely a neutral factor at this point. Technically, gold still needs to overcome short term resistance levels.

All in all it seems likely that the market will remain choppy and volatile, but the action in gold stocks gives some grounds for hope that a mild upward bias can be maintained – with the caveat that the recent uptrend is not yet strong enough to sound an all-clear. The biggest positive factor remains sentiment, which is so negative that it will likely continue to limit downside moves.




Charts by: StockCharts, Sentimentrader, BarCharts




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2 Responses to “Gold Sector in January: Most Hated Sector, Best Performer”

  • Vess:

    A few technical anaysis remarks:

    1) Ratio charts are fine for detecting divergences but I’ve always found it a bit of a stretch when chart patterns and overbought/oversold indicators are applied to them. Use with care.

    2) StockCharts doesn’t display all kinds of ratio charts correctly. To see what I mean, display the candlestick chart of the ratio $SPX:$SPX. It ought to be one “line” (all candlesticks having a zero height), right? Well, you’s be surprised by the result. The problem is that StockCharts divides only by the closing prices of the denominator. So, *always* use line charts when displaying ratio charts. Everything else (candlesticks, bar, etc.) would be misleading.

    3) Do not use MACD to show overbought/oversold over long periods of time. Use PPI instead. (And use log-scale charts, of course.) I think there is an article on the StockCharts site somewhere, explaining why you should do so.

    4) One additional reason why the Elliott wave labeling is iffy is because gold spot didn’t make a new low in December, while the continuous futures contract did. So, it is not clear which one should be labeled as end of wave II. You have a point, though, that the correction might not be over yet and it doesn’t matter in the long run anyway. I am not a big fan of e-waves myself – I find them way too subjective and overloaded with meaningless rules. My own analysis suggests that the correction is over – but I’ve been wrong before.

    5) The Chindian gold imports might not matter per se (as demand for gold impacting the price) – but their *perception* matters. The gold price could fall not because China and India are importing less but because the traders believe that they will be importing less and that the price ought to fall. (As Nietzsche, I think, once said – there are no facts, only perceptions.)

    6) The main fundamental fact about gold that is worrying me is that currently the “real” yield, as measured by the yield of the 10-year Treasury minus the CPI, is positive.

  • SavvyGuy:

    About the long term wave count of gold:

    Classic Elliott Wave theory suggests that the A-B-C correction from the all-time high in 2011 will eventually bottom out near the “4” low from the preceding advance, which is in the $700 range. This seems like a long ways down even from current price levels, but the 33-year old bond-market bull is getting long in the tooth, and rising yields are always corrosive for PMs.

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