Oversold Gold Stocks

Gold itself continues to look rather wobbly as the daily chart of the August futures contract shows. However, with credit spreads beginning to rise and recent economic data showing that the much-discussed 'tapering' of the Fed's monetary pumping is probably still not on the menu in the near future, the fundamental backdrop for gold is certainly not getting any worse. It seems likely that the market will be in a 'holding pattern' until the payrolls report is published on Friday, and since it is unknowable what the report will look like, anything could happen in the short term.

 


 

 Gold,daily 


Gold, August contract daily. Still going nowhere and not looking particularly strong – click to enlarge.

 


 

 

That said, as James Debevec has pointed out in a recent article at Minyanville, when gold stocks fall as much below their 252 day moving average as they have recently done, then the remaining downside potential has historically been very small (with the sole exception of the 1976 decline) and subsequent rallies have been quite sizable. The current 'oversold' signal has occurred seven times since 1969 and the results of the previous occurrences can be seen in the table below. Note that with the exception of one instance, there was some additional near term weakness every time, but it was only transitory – in fact, the bigger the additional weakness, the bigger the subsequent rally turned out to be. The risk-reward equation was extremely favorable every time:

 

 

 


 

Debevec20130603p5


James Debevec's table of extreme gold stock oversold signals with the additional drawdown after the signal was received and the size of the subsequent rallies. These were well worth playing even during gold's secular bear market.

 


 

HUI to SPX Ratio – a Turnaround in the Works?

This brings us to the HUI-SPX ratio, which has declined sharply and almost non-stop for many months. Recently it has hit a low though that may well turn out to be a major one. It has all the hallmarks of a change in trend:

 


 

HUI-SPX-ratio

 

The ratio of the HUI to the SPX: the recent low was accompanied by typical momentum divergences and a usually powerful MACD buy signal is in evidence (two buy signals in a row, with a price divergence) – click to enlarge.

 


 

A look at a longer term chart of the ratio that plots the entire decline since the 2011 peak shows how much potential for a sizable retracement there is (in other words, even if gold stocks should only manage a bear market bounce, it should be quite a big one):

 


 

HUI-SPX-LT




The HUI-SPX ratio, long term. Since the peak in 2011 there has been a relentless decline. That also means that there is relatively little overhead resistance. A large rebound in this ratio over the medium term is highly likely – click to enlarge.

 


 

Conclusion:

There could be another bout of near term weakness in the gold sector based on the historical data put together by James Debevec. However, such near term weakness would likely represent an excellent opportunity. Moreover, the ratio of gold stocks to the broader stock market is clearly in a bottoming process. A little bit more patience and nerves may be required, but risk-reward in the sector looks quite good at the moment.

 

 

Charts by: StockCharts, BarCharts, table by James Debevec


 

 
 

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