From Consolidation to Breakdown in One Week

Last week prior to the ECB announcement and the US payrolls report, gold and gold stocks drifted lower, as they always do ahead of these events. Until Thursday the relative strength in gold stocks and the price charts of the gold stock indexes themselves hinted at a routine consolidation from a technical perspective.

This changed rather markedly on Friday, when gold once again fell below the $1200 level in a knee-jerk sell-off following the superficially strong payrolls report, which “exceeded expectations”. The household jobs report was actually far weaker than the payrolls data and the size of the labor force was once again revised lower. We keep wondering how market participants can make any decisions based on this report, which as a rule is revised out of all recognition over the 12 months following its release. Moreover, employment is a lagging economic indicator anyway. However, things are what they are; since the Federal Reserve’s dual mandate includes an employment component, and the central bank is like a driver doing 200 on a highway while staring fixedly into his rear-view mirror, it is held that even a payrolls report that is only superficially strong will bring the timing of the widely expected rate hike forward. This time not even the otherwise impervious stock market was able to escape that conclusion.


(FILES) This undated handout image court

Photo credit: AFP / Getty Images


In addition, the blow-off move in the US dollar became even more pronounced. We can’t remember too many historical instances of a more crowded trade, and yet, it continues to work – a phenomenon we have observed in currency markets for some time now (extremes in sentiment and positioning data haven’t even managed to slow recent currency trends down a little).

Below we show a few charts illustrating the current situation in detail. While selling in the gold sector has resumed and panic volumes similar to those seen late last year have returned, there are still a number of significant divergences in evidence that may well come to matter going forward. Technically, the sector looks quite vulnerable again, as an important support/resistance level has just given way. This may well lead to a retest of last year’s lows, or even a decline to a lower low. It would obviously be better though if a higher low were put in instead.

Are there any reasons to expect that this may happen? Not necessarily based on the technical condition of the charts of gold stock indexes and ETFs, but various ratios actually point to a sizable improvement in gold mining margins in spite of the weakness in the nominal gold price. This is often the precursor to a better performance of the sector over the medium to longer term – and at the beginning of longer term rally phases a number of divergences between the USD gold price and gold stocks are usually put in over an extended time period (this can be a very drawn out process).

First a look at the HUI and the HUI-gold ratio, both of which illustrate last week’s breakdown:


1-HUI daily and HUI-gold ratioThe HUI daily, plus the HUI-gold ratio. The latter should either show strength (to confirm an uptrend is underway) or at least deliver a positive divergence at lows – click to enlarge.


The next chart shows the gold miners ETF GDX – this serves mainly to illustrate the fact that panic volume has returned to the sector last Friday. Near both the 2008 and 2014 lows, it usually took several days of exceptional volume before a durable reversal occurred, but not all of these high volume trading days were actually down days.


2-GDXGDX: panic volume is back – click to enlarge.


We still think that the panic volumes seen last year make it likely that this was a significant turning point, but if trading volume becomes even larger in the current move, we would have to revise that view. It should also be mentioned that not much can be concluded from the knee-jerk reaction to the payrolls report; the activity over the subsequent one to two weeks is as a rule more informative.


Gold vs. Currencies

Obviously, the above charts are not particularly encouraging, and neither is that of gold itself priced in US dollars. However, priced in euro and yen, the recent decline in gold still looks like a normal pullback in a new uptrend. On the other hand, if the dollar price of gold were to decline below last year’s low (which isn’t too far away), a move to the “price attractor” region around $1,040 to 1,050 – the 2008 high – would become likely. We have previously discussed this possibility, but the preceding move above the first layer of resistance temporarily shelved that possibility. From a technical perspective it has to be once again considered now (i.e., it doesn’t have to happen, but cannot be ruled out either).


3-Gold in different currenciesGold priced in terms of the three major fiat currencies. It looks weak in dollar terms, strong in euro terms and somewhat non-committal in yen terms – click to enlarge.


As the chart above indicates, gold is actually still diverging considerably from its usual negative correlation with the US dollar. This is a trend that has been in evidence since last year’s lows in the gold price. Whether it continues remains to be seen, but similar divergences have often heralded medium term turning points in the past. However, crowded trade or not, the uptrend in the US dollar index certainly continues to look quite convincing.


4-Dollar vs goldThe uptrend in the US dollar looks quite good, but the fact remains that gold isn’t “confirming” it – click to enlarge.


Gold vs. Commodities

The next chart shows the ratio of gold vs. crude oil and the ratio of gold to the CCI (continuous commodity index). These charts are very important with respect to gold mining margins. Energy is a major cost input in large open pit mines, while a rise in the gold/commodities ratio generally indicates two things: 1. gold’s purchasing power is actually increasing and 2. economic confidence is weakening. The latter shouldn’t be too big a surprise, as US economic data excluding the last several jobs reports have been quite underwhelming in recent months (while euro area data have actually improved relative to expectations in the wake of the massive expansion of the money supply there).

5-Gold-oil and gold-commodsGold relative to crude oil and commodities – this indicates that gold’s purchasing power is increasing, which means gold mining margins are improving in spite of a weak nominal USD gold price – click to enlarge.


In this context, we want to show the chart of the 2000/2001 low in the gold sector again. There are several interesting parallels to today: at the time, gold’s nominal price remained weak, but it started to strengthen against most industrial commodities, many of which only bottomed many months later. Also, the dollar was in a very strong uptrend, which supported by the fact that the Fed had embarked on a small rate hike campaign between mid 1999 and mid 2000 (note that the actual low in the gold price occurred very shortly after the first of altogether five rate hikes). Of course these rate hikes were taken back at warp speed as the late 1990s stock market bubble began to collapse.

We would suggest that the same fate awaits the current episode of Fed tightening (note that the cessation of “QE” already amounts to a tightening of monetary policy). Gold should eventually begin to reflect this, but it a sizable downturn in “risk asset” prices may be needed to get it going. Keep in mind that the process may not follow the exact same script in terms of leads and lags this time – so it is difficult to tell where exactly we currently are with respect to it.


6-HUI historicalHow the gold sector bottomed in 2000/2001. There were two divergences: first, gold made a higher low relative to gold stocks in November 2000 (compared to its 1999 low), then it made a lower low relative to gold stocks in April 2001


The important message from the chart above is that 1. gold stocks will anticipate an emerging uptrend in gold, and can do so with a considerable lead time and 2. this tends to happen just as economic confidence is beginning to wane and gold mining margins improve. Another point worth mentioning is that the chart of gold looked atrocious when it made its low in 2001, so a “bad looking chart” is not a guarantee that the previous trend will continue. Most charts look bad at lows and good at highs.



Sentiment on gold is not quite as negative as it was at the November 2014 low (which was actually accompanied by a few sentiment divergences as well, though not in terms of the indicators shown below). The net speculative long position in gold futures is larger, sentiment surveys show less negativity, and the discounts to NAV of closed-end bullion funds are not quite as pronounced (all these data points are likely to worsen if the decline in prices continues).


7-Gold sentiment-1Discounts to NAV of closed-end bullion funds, and Rydex precious metals assets and cumulative cash flows – click to enlarge.


Unfortunately the message from sentiment indicators is open to interpretation. We would prefer to see sentiment to be more negative with prices actually higher, since that would represent a straightforward bullish divergence. However, it sometimes happens the other way around: with prices either lower or closing in on previous lows, and sentiment actually slightly better than on those previous occasions. One thing is clear though, namely that sentiment is quite subdued again, even if there is still room for it to become even more so.



We are left with a few if/then possibilities, depending on what happens in the short term. Gold sector charts are definitely looking technically weak again, so it may take even longer to finally put in a durable low (the decimation of the coal sector shows what a worst case scenario can look like). On the other hand, there is a strong case to be made that gold mining margins are actually improving noticeably in line with waning economic confidence, regardless of the weak nominal USD gold price. It is therefore possible that a secondary, higher low/divergence is going to be put in.

This will require that the relative strength of gold vs. foreign currencies and commodities remains largely intact. Monetary policy is getting looser all around the world, with the US representing the lone exception at this point. This is based on the idea that the US economy has “decoupled”, but it seems more likely to us that it is simply lagging economic trends elsewhere. One must also keep in mind that there is a kind of “game of chicken” underway (to borrow a Fleckism) in the context of the latest credit and asset bubble blown by loose central bank policy. As always, such bubbles are wrongly held to be sustainable after they have persisted for a good while, but they never are. The question is mainly when the point of recognition will actually arrive. Gold should eventually begin to discount its approach, and the performance of gold relative to commodities is actually a first small hint in this direction.

What needs to be watched now is how the next short term low is formed. If it occurs in concert with divergences such as those discussed above, we would take that as a bullish sign. If on the other hand, gold and gold stocks as well as gold in non-dollar currencies vs. gold priced in the dollar all begin to mutually confirm new lows, it would be a sign that the bear market is likely to continue for longer. We personally still don’t think it will (as for instance the gold price in euro is highly likely to remain in non-confirmation mode, and the large trading volumes near the 2014 low remain indicative of a typical panic bottom), but our opinion does not matter. As an aside, the fundamental macro-economic drivers of the gold price remain overall in mixed/neutral mode for now. We are quite sure that they will eventually turn unequivocally bullish, but it is unknowable when exactly that will happen.


Addendum: Miners in the Sun

If the real price of gold continues to increase, it will be “miners in the sun” time:


The lyrics are complete nonsense and the singer has an odd accent (ooooddeerrr side), but the miners sure could use some time in the sun for a change.


Charts by: StockCharts




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5 Responses to “Gold and Gold Stocks Break Down Again – What to Look For”

  • Mark Humphrey:

    “Monetary policy is getting looser all around the world, with the US representing the lone exception at this point.”

    Someone I read in the past couple of days pointed out that in emerging markets, a passive tightening is underway. As the dollar makes it run to the moon, those countries stop buying dollar assets and may begin to sell those assets instead. Since monetary inflation is (supposedly) executed in small trading nations via foreign exchange rate manipulation, when the dollar bull makes EM currencies fall, the necessity of monetizing dollar assets is eliminated. If this is true, that amounts of a pause in EM money printing.

    Of course, most bigger nations are once again stepping up the pace of money pumping. So maybe that obviates the point I made. Except the EM are a big share of the world today.

    Thanks for your many excellent articles and insights.

  • Kreditanstalt:

    One more thing, an honest question…how is it possible for “the gold price” to fall continuously and simultaneously against ALL currencies given that some of them are comprised in the dollar index and that gold is sold in the USD – a currency which, in rising lately, necessarily depresses other currencies in the process?

    • RedQueenRace:

      If gold falls 10% against the dollar and other currencies fall, say, 5% against the dollar, gold will be down against them all. Gold could just be viewed as the weakest performing currency.

      • rodney:

        Agreed … you know you live in a totally screwed-up, upside-down world when you can put the words “gold” and “weakest currency” together in the same sentence.

  • Kreditanstalt:

    “We keep wondering how market participants can make any decisions based on this report”

    But they don’t. Market participants make decisions based on what they THINK THE HERD WILL DO after the report.

    And, in a nutshell, that’s why both fundamentals and technical analysis will continue to mean nothing without an exogenous shock. A BIG and much-needed one…

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