A Fascinating Parallel

We have recently discussed the sentiment and positioning backdrop in gold on two separate occasion, as it has once again reached rarely encountered extremes (see Gold Panic and “Gold and the Grave Dancers” for details).

 

mineImage via bullionstreet.com

 

Not much has changed on that front, except for the fact that small speculators have increased their net short position in COMEX gold futures to the highest level in nearly three decades last week.

 

1-Gold CotsThe last time small speculators (red line) held a similarly big net short position in gold futures was in the late 1980s – click to enlarge.

 

Steve Saville has mentioned an interesting parallel between the situation near the November 2000 low in the HUI Index and the current one in the weekly market update of the Speculative Investor newsletter. As he points out, this is only relevant with respect to the technical picture and the sentiment situation, as the fundamental backdrop is certainly different. With a hat tip to Steve, we want to briefly show this parallel here as well.

First a chart of the HUI, gold and the HUI-gold ratio year-to-date. As can be seen, there is now a price/RSI divergence in place in the HUI, and after a relentless decline followed by a string of “uncertainty candles”, it has finally produced a strong up day. Note especially the period within the green rectangle:

 

2-HUI and Gold today-1The HUI, gold and the HUI-gold ratio. Gold has been in a downtrend, but the decline in gold stocks has been far more pronounced – click to enlarge.

 

Next comes a chart that shows the HUI, gold and the HUI-gold ratio between September and December of 2000 – once again focus on the period highlighted by the green rectangle:

 

3-HUI and Gold in 2000-1The low in gold stocks in November of 2000 – the period preceding the low is almost a spitting image of what has recently happened – click to enlarge.

 

Of course, chart comparisons and historical parallels are usually a dime a dozen – but in this case, it is not just one parallel, but a string of them, i.e., we can see exactly the same divergences playing out while the sentiment backdrop is very similar as well.

If there is follow-through buying after the strong bounce in the HUI Index on Monday, then we could in fact state that we have an extremely compelling parallel here. Having said that, one should be careful not to make too much out of it – all will depend on how precisely things will play out from here on out.

Luckily, the gold sector is usually quite good at providing high confidence short term signals. For one thing, its performance can always be compared to that of gold itself and its relative strength, resp. weakness is often (but not always) informative. Secondly, the shape of the sector’s rallies and declines is often easily identifiable as either corrective or impulsive – presumably a side effect of its rather modest liquidity.

 

A Strange Data Release From China – Has China Bought More Gold?

On a different, if related subject, China has released data on its monetary reserve assets for July yesterday. They look as follows:

 

4-China Reserve AssetsChina’s monetary reserve assets – June and July compared – click to enlarge.

 

As a friend has pointed out to us, if one looks at the dollar value of China’s gold holdings reported in June and July, it actually appears as though it has added to its gold reserves in July. We are not sure on what prices the data are based, but if one simply uses the month-end prices of gold in June (USD 1,170) and July (USD 1,080), then the above data indicate that China must have bought approximately 47 tons of gold in July according to our calculations (feel free to check for yourself – here is a tool that can be used to quickly convert troy ounces to metric tons).

It is possible though that an average monthly price has been used to calculate the value of China’s gold reserves – we don’t know for certain. We haven’t made the effort to make the calculation above based on an average monthly price, so we don’t know what the difference would be in this case, but presumably it would be somewhat smaller (our friend has mentioned approx. 25 tons).

In any event, this would be remarkable for two reasons: for one thing, China has only very recently announced a fairly big jump in its gold reserves (by more than 600 tons) that has supposedly taken place in June, or rather, has been accounted for in June. Secondly, no separate announcement about any additional recent increases in its gold reserves has been made as of yet. Nevertheless, if the values shown above are correct (the image is from the official data release), it must have added a bit to its gold reserves last month as well.

Keep in mind that this is not directly relevant to the gold price – a purchase of between 25 to 47 tons in one month is a drop in the ocean given the gold market’s liquidity and total size – but it could have a psychological effect on the market.

As an aside to this, China has made an important announcement overnight regarding the yuan: Namely that it is devaluing its official target exchange rate to the lowest level since 2012. As Reuters reports, this move has probably made the assorted mercantilists and inflationists running central banks in the region happy, because scores of other Asian currencies immediately sold off in sympathy:

 

“The U.S. dollar lurched higher on Tuesday as China allowed its yuan to fall to levels last seen in 2012, a shift that could provide a competitive boost to exports for the world’s second-largest economy.

Asian stocks turned mixed as investors weighed the implications of the surprise move, which seemed to end months of officially sanctioned yuan strength. China’s central bank set the midpoint for its currency at 6.2298 per dollar CNY=SAEC, down from Monday’s fix of 6.1162, and said it was aiming for a depreciation of 2 percent.

Markets reacted by selling the Australian dollar, often used as a liquid proxy for the Chinese currency. The Aussie AUD=D4 sank to $0.7314, compared with $0.7430 ahead of the news. Other currencies in the region also lost ground to the U.S. dollar as investors reasoned they would need to fall to keep exports competitive with China.

“As this event has boosted the U.S. dollar and dampened local currencies, it is likely to be welcomed by regional central banks,” said Annette Beacher, chief Asia-Pacific macro strategist at TD Securities.

 

(emphasis added)

Allegedly, the devaluation will be “good for growth”, which is of course complete nonsense. It will merely subsidize the export sector to the detriment of everybody else in the economy. Even this subsidy will prove to be fleeting, as domestic prices will quickly adjust to the situation.

 

5-USDCNY(Weekly)A weekly chart of the USD-yuan exchange rate. Note that the bulk of the last candle has been produced overnight.

 

It certainly looks as though the still inconvertible yuan has entered a downtrend. Incidentally, the announcement initially spurred a renewed sell-off in gold as well as in various industrial commodities, but the gold market has strengthened again subsequently and has been quite volatile so far (i.e., as of the time of writing, about three hours before the official COMEX opening).

 

Conclusion

It will shortly become clear whether there will be any follow-through buying in the sector – if so, then the action after previous lows of varying importance (such as in 1976, 1986, 1998 and 2000) will provide a helpful guide with respect to the move that can be expected in the short term (the immediate moves off these lows were all very similar in shape and size). The medium term outlook will only become clearer at a later stage – even if a strong short term bounce were to occur here, one cannot be certain that “the” low is in yet. One thing is clear though: the technical and sentiment backdrop is more than ripe for a playable rally.

 

Charts and tables by: Sentimentrader, StockCharts, investing.com, PBoC

 

 

 

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2 Responses to “Gold Stocks at an Interesting Juncture”

  • Kreditanstalt:

    BTW, official sector perception management is, as usual, always at work.

    China counterfeited again this morning. And, as yesterday, “the gold price” initially fell some before starting the inevitable uptrend. But from an artificially lower point…

    I wouldn’t be surprised if BIS-via-proxy selling of unbacked paper gold futures occurs immediately after these currency depreciations. Perhaps the PBOC and the BIS talk to each other…?

  • Kreditanstalt:

    “…China allowed its yuan to fall to levels last seen in 2012…” (???)

    Peculiar choice of words there. “ALLOWED…to fall…”? “Allowed”?

    Sounds almost as if the entire China Growth Story, so eagerly believed by managed money, might actually be some kind of Potemkin Village…

    Hmmm…

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