The arrival of the Qu.2 earnings season was not kind to the gold sector (earnings season almost never is as it were). Goldcorp (GG) and Aurico (AUQ) had to release negative operational guidance, both GG and Barrick Gold (ABX) missed their earnings estimates, Novagold (NG) was hit by news that its joint venture partner ABX was postponing a development decision on its main asset Donlin Creek indefinitely, and so forth.
We have noticed that even the relatively provincial financial press in small European countries has picked up on the bad performance of gold stocks lately, which is the functional equivalent of the story making the front page of 'Reader's Digest'.
The rally in the HUI index that started in May was thus cut short and the sector declined again for what looks like a retest of the low. Interestingly, the past two days have seen it shrugging off further bad news – instead it reacted to a firming gold price.
The HUI declines to re-test its May low. An MACD buy signal seems imminent - click chart for better resolution.
On a longer term chart, we can see that the May low in the HUI was actually a retest of the 2006 high (!), a level that was achieved when gold first crossed above the $700 level (gold is now trading 125% higher).
It would be fair to say that gold stocks have provided investors with negative leverage to gold, in spades.
The May low in the HUI index was in fact a retest of the 2006 high - click chart for better resolution.
Consequently the XAU and HUI ratios to gold have plunged. In case of the XAU-gold ratio, it is now well below the level recorded at the end of gold's 20 year long bear market in the year 2000. This provides us with a bit of perspective as to how incredibly cheap gold stocks have become.
The HUI-gold ratio and the gold price in dollar terms (green line) - click chart for better resolution.
The XAU-gold ratio and the gold price (green line). The ratio is now below 10 – at the bear market low in the year 2000 it stood at about 16. In other words, people are today more bearish on gold stocks than they were at the end of a grueling, 20 year long bear market - click chart for better resolution.
Many reasons have been forwarded as to why gold stocks have declined so much. They range from political risks ('resource nationalism') to rising costs, to declining ore grades, to a dearth of discoveries to rising development costs to the precious metals ETF's attracting investor funds that used to be invested in gold stocks.
All of these arguments are quite reasonable, but as we have pointed out before, the very same things could have been said while the gold stocks were still rallying.
In other words, not one of these rationalizations makes any sense in terms of explaining the price action of recent months. The profit margins of gold mining companies on average are – even with all those negatives baked in – at an all time record high.
This leaves us with the only explanation that actually does make sense: people are simply bearish on gold itself and believe that its bull market is over. However, this belief is almost impossible to reconcile with the price chart of gold itself, which looks bullish in terms of every fiat currency it is measured in. In fact, the recent consolidation since the 2011 spike high looks very similar to the consolidations experienced in the past. Moreover, a rally that really smacks of 'bubble conditions' has yet to occur. In the 1970's, gold rose by 100% in one year (1974) and then it even rose by 200% in another year (1979). Nothing even remotely resembling these 'bubblicious' advances has happened in the current bull market. Not yet, that is.
Gold in dollar terms, weekly - click chart for better resolution.
Gold in euro terms, weekly. If people were to focus on this chart, sentiment would probably not be as bearish as it is right now - click chart for better resolution.
Gold in euro terms, daily. It actually looks as though it is about to break out to new highs soon - click chart for better resolution.
Gold in Rand terms, weekly. This too looks as though the action since September 2011 was simply a bullish consolidation - click chart for better resolution.
This brings us to the question whether it is possible to ascertain the state of sentiment aside from the obvious price action. Luckily it is in fact possible to do so. Below are three charts that illustrate where things currently stand.
Mark Hulbert's HGNSI (Gold Sentiment Newsletter Sentiment Index). This has lately fallen to minus 14.8%, which means that on average, gold timers are currently recommending allocating 14.8% of one's portfolio to a short position in gold. As you can see from this chart, when they all agree, they usually tend to be wrong - click chart for better resolution.
Gold, public opinion, via sentimentrader. This chart amalgamates the readings of several sentiment surveys. Bullish sentiment continues to wallow near the levels seen at the 2008 low - click chart for better resolution.
Public opinion on silver – this chart is similar to the preceding one, in that it amalgamates a number of sentiment surveys. In silver, bearish sentiment has been at an extreme level for several months as well - click chart for better resolution.
In spite of the disappointing price action in gold stocks (which have only turned up again over the past two trading days) it is probably not a good time to 'throw the towel'. Admittedly, until gold in dollar terms breaks above the resistance in the $1630-$1640 region, the consolidation phase may still continue for longer. Also, an eventual breakdown below lateral support can still not be ruled out (support currently resides in the $1525-$1535 region). We have recently shown the chart below that depicts the 1970's gold bull market, with all the consolidation triangles that occurred during that advance:
The 1970's gold bull market: triangles marked in red led to an upside breakout, those marked in green to a downside breakout - click chart for better resolution.
This shows that triangular consolidations do not always lead to a continuation of the previous uptrend. In fact, downside breakouts must be taken very seriously. However, it also shows that these consolidations lead to a resumption of the primary trend far more often than not.
Given the bullish fundamental backdrop for gold – real interest rates remain negative and central banks seem eager to resume monetary pumping as economic confidence once again wanes – the probability is high that the current consolidation phase will once again lead to an upside breakout. If this is indeed the case, then gold stocks are a screaming buy at current levels, in spite of all the well documented problems.
The caveat is that the May low in the HUI index is really an important line in the sand. Should gold unexpectedly break below the lateral support level discussed above, then gold stocks would likely also break below this old support/resistance line. If this were to happen, it would have to be regarded as a very bearish development. The good thing is that buyers therefore have a clear stop loss level that is not too far away from current prices, which means that risk can currently be greatly minimized – something that is rarely the case in this volatile sector.
Addendum: Chinese Rebar Prices
Yesterday we came across the below chart depicting rebar prices in China ('rebars' are the twisted steel coils used to reinforce concrete). This seems to confirm that China's property sector is really in trouble now – and with it, the steel sector and very likely the entire economy. The recent somewhat better HSBC flash PMI is certainly not enough to sound the 'all clear' for China's economy.
Rebar prices in China fall to a new low for the move.This is probably a good indicator of the true state of China's economy, which is highly dependent not only on exports, but also on construction activity – click chart for better resolution.
Charts by: bigcharts, stockcharts.com, sentimentrader, Bloomberg, St. Louis Fed.
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