Gold Stocks Reach 'Oversold' Record

In last week's update on the gold sector,  we neglected to point out that gold stocks actually reached all time record oversold levels before reversing on Thursday.

As Steve Saville points out here, the gold sector has indeed never before traded this far below its 200 day moving average. Mr. Saville employs the BGMI (Barron's Gold Mining Index) in his analysis, as it is the oldest gold mining stock index – in fact, the BGMI allows us to look as far back as the 1940s. The historical record is actually quite clear with regard to what tends to happen after such 'oversold' extremes are recorded.

 


 

HUIGold stocks produce an 'oversold' record amid price/momentum divergences – click to enlarge.

 


 

Mr. Saville writes:

 

 

“It turned out that almost anything was possible, because at last week's low the HUI was 55.9% below its 200-week MA. Therefore, using either the BGMI or the XAU as a sector proxy up to and including 2000 and the HUI as a sector proxy thereafter, at last week's low the gold-mining sector of the stock market was further below its 200-week moving average (MA) than it had ever been.

We know from painful experience that there are no absolute benchmarks when it comes to sentiment and 'oversold' extremes, so the current extreme does not provide buyers with a guarantee of success. However, it isn't every day that you get the opportunity to buy an investment at its most 'oversold' level in history.”

 

(emphasis added)

It is true that there is no 'guarantee of success'. In fact, we suspect that the lows may well be retested later this year, although this is not certain either. For instance, the extreme lows of 1976 and 2008 were not retested. Once the lows had been put in, the sector took off like a scalded cat. Although there are no guarantees as to what to expect from here on out, there are a few things that are certain. The most important one of them is that when a sector becomes this oversold, it means that there are extremes in emotion in play that are fairly rare. This was an utter capitulation, something that was underscored by a number of former bulls offering public 'mea culpas' while lowering their expectations accordingly, the mining industry complaining that the current gold price renders its business unsustainable and so forth (see this write-up at Market Anthropology for details on these points). Historically, such extremes in emotions don't just tend to produce 'short term lows'. It is far more likely that lows produced in the context of such extremes of fear and capitulation will later turn out to have been major turning points. Of course it cannot be ruled out that even bigger extremes will be seen – we are assessing probabilities, not certainties.

 


 

bgmi

A long term chart of the BGMI, via Sharelynx (it has in the meantime declined even further). Note the two major cyclical bear markets within the secular 1970s bull market – click to enlarge.

 


 

Short Term Outlook

At the moment, gold and gold stocks are pulling back again, likely because  the usual 'fear of the payrolls report' is striking. The idea is that a good jobs report makes 'QE tapering' by the Fed more likely, hence the gold market always pulls back ahead of the report in case it turns out to be strong (as ridiculous as this is, it is how it seems to work).

To this we would note that if the trend has indeed changed from down to up – even if it should turn out to be only a short or medium term change in trend – then the market will ultimately proceed to ignore the jobs report beyond its very short term (one day) effect on the day of the release.

 


 

gold-30-minGold, 30 minute chart. A pullback ahead of the jobs report – click to enlarge.

 


 

In short, the manner in which the gold market reacts to the payrolls report over the subsequent week may actually be quite informative this time around, especially if the market ignores a fairly strong report. This would be a first hint that the long term bullish gold market drivers are beginning to trump the short to medium term bearish ones. Conversely, a negative reaction – especially a negative reaction to a relatively weak or neutral report – would give us a hint that the short/medium term downtrend is not yet over.

However, we don't want to get ahead of ourselves here. We will simply have to wait and see what happens in this case. Still, we thought it was worth pointing out that this week's payrolls report could provide us with valuable information regarding the short to medium term trend.

 

Sentiment Update

Lastly, the most recent update of the Hulbert Gold Newsletter Sentiment Index (HGNSI) shows that the index went right back to its all time low just prior to the recent recovery in prices (actually, the reading was slightly above the all time low recorded previously):

 


 

HGNSIThe HGNSI drops back to its recent lows – click to enlarge.

 


 

This update is from June 27, and it means that on that day, gold timers on average recommended to their subscribers to hold a 43.3% net short position in gold. That continues to represent a quite extreme bearish consensus. In fact, it is unprecedented.

Should gold and gold stocks turn around, there is therefore a lot of pessimism that could be unwound. Stay tuned.

 

 

Charts by: Sharelynx, Sentimentrader, StockCharts, BarCharts


 

 

 

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10 Responses to “Gold and Gold Stocks – A Study in Extremes”

  • dago8231:

    “Is this the prelude to the deflationary unwind (of historic proportions) predicted by Robert Prechtor? Is gold headed to $400?”

    With the cost of actually mining an ounce of gold at around $1200-$1300 an ounce, absolutely massive demand for physical gold in China, Asia and the middle-east and oil prices nearing $100 a barrel this comment would have to be one of the most stupid I ever read. You would have to be an American.

    • APM:

      Why is JoeBren’s comment stupid? Maybe Robert Prechter’s scenario is unlikely to (fully) materialize, but it is not impossible at all. All it takes is a 2008-like crash starting in the emerging market with the Fed halting securities purchases exactly at the wrong time. A scenario with crude oil down to $30 per barrel, the CCI index down 50% and the emerging market currencies (proxy for labor costs) down 50% plus versus the USD is enough to cut gold mining costs outside of North America to about $500 per ounce. Maybe the probability of such a scenario happening is 10% and not, for example, 50%, but I would not dismiss it entirely so easily.

      • worldend666:

        I don’t see what the mining price has to do with the price of gold. All the miners in the world could go bust tomorrow and gold would still have a market with a price determined by supply and demand for the underlying commodity.

        Sure gold can go to 400$. In fact the paper price could fall to zero if delivery fails at an important exchange. That’s not to say gold itself would trade at zero in that scenario, but everyone watches the paper price.

        • APM:

          Fair enough, I was just replying to the mining costs argument. Actually, all the miners in the world going bust would be a positive event for the price of gold, eventually, everything else being equal.

          Nevertheless, Robert Prechter’s massive deflationary scenario is potentially negative for gold, of course independently from mining costs, because of the liquidation which would ensure. But no one really knows, even in a deflationary crash like 2008, gold might be the first asset to recover and the dip might be relatively shallow.

      • JasonEmery:

        APM said, “Why is JoeBren’s comment stupid?” and “A scenario with crude oil down to $30 per barrel….”

        ‘Stupid’ is kind of harsh, but if you look at the financial pages, you will see that oil is going up over $101.50/bbl today, and not headed toward $30. So, rather than confirming gold’s recent plunge, oil is actually casting doubt on the relevance of gold’s recent weakness.

        Money, and money-like claims, such as unfunded liabilities of nations like the USA, QE-3 bond buying, etc., are increasing exponentially. This is hyper inflation. It has to eventually leak out into the real economy. Right now, it is leaking out into the petroleum markets. Possibly because oil exporters are privy to the same information we are, and much more. It is also causing huge concern among bond buyers, leading to bond price weakness and bond yield strength.

        Gold and oil do not trade in lock step. However, gold will not be left behind if oil continues to rise.

        • APM:

          I’m not so sure that the price of crude oil is going up. Yes, the WTI has been going up lately but that has not been the case for the Brent, which is now trading at the lowest premium, percent-wise, vs. the WTI since the end of 2010. And both the WTI and the Brent peaked in 2011, similarly to many commodities and emerging markets. We shall see …

          • JasonEmery:

            The usa federal government is running a GAAP fiscal deficit of $7 trillion per year, or about 40% of GDP. Yet you won’t leave a stone unturned, looking for some tiny possibility of deflation, lol.

            If you want to argue that there will be a military coup, and the military rulers will nullify all claims for social social security, medicare, VA benefits, federal employee pensions, etc., in order to eliminate unfunded liabilities, then yeah, there is a case for deflation.

            • worldend666:

              Surely there has been a lot of price deflation since 2007? House prices has to be the biggest market out there and drops of 30% since 2007 is absolutely massive. Just because the statisticians don’t count house prices in the inflation statistics, it doesn’t mean that they don’t count.

    • SavvyGuy:

      @dago8231:

      JoeBren did not make any statements. He asked two rhetorical questions, which is a perfectly valid mechanism for provoking further thought!

  • JoeBren:

    Is this the prelude to the deflationary unwind (of historic proportions) predicted by Robert Prechtor? Is gold headed to $400?

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