A Negated Breakdown

There have been remarkable gyrations in the gold sector lately. The typical rebound out of a November/December low (typical in recent years after the end of the tax loss selling period) was initially cut short in January in the course of the global stock market decline. This was a bit surprising, because it was widely held that the recovery in the gold price was a result of said stock market decline.

 

goldmine-700x360Photo via genius.com

We suspect that in it was initially still widely expected that stock market weakness was just a fluke and that the downtrend in the gold price would therefore soon resume. Moreover, base metal mining stocks were pounded mercilessly and as we have previously discussed, there is a completely illogical short term correlation between this sector and gold mining stocks, likely due to various tracking products and the mindless automatic buying and selling associated with them. From a technical perspective the action has created quite an interesting situation though:

 

1-XAU-HUI breakdown and reversalXAU and HUI daily. After initially beginning to recover from November, resp. December lows, both indexes sold off sharply after the first trading week in January, and in the process broke below a previous support level that has been tested many times and has up to that point always held. It looked like yet another breakdown in the long-lasting bear market was underway – but the indexes quickly reversed back above the broken support line – click to enlarge.

 

As the chart annotation indicates, the recent reversal is definitely positive. Both false breakouts and false breakdowns often turn out to be reliable trend change signals. An additional bonus in this case was that the initial breakdown has induced widespread capitulation (judging from anecdotal evidence).

 

Advance in Gold Characterized by Caution

What looks encouraging as well is the recent saucer-shaped bottom in gold – usually this kind of formation leads to a fairly decent rally:

 

2-Gold saucerGold begins to rise out of a saucer-formation – click to enlarge.

 

Contrary to the immediately preceding rally attempt, the current one has been a “scared rally” so far. There has been fairly little speculative buying in COMEX futures, and small speculators have actually remained net short up until last week, when their net position turned roughly neutral.

 

3-Gold CoT-1Speculative buying in COMEX gold futures has so far been far more subdued than during previous rallies – click to enlarge.

 

The mainstream financial press is still busy penning obituaries on gold, which is generally a good sign as well. A playable rally should be widely disbelieved in its early stages. According to the article we have linked to “many still don’t see a bottom”, but in terms of major non-dollar currencies it has of course occurred a few years ago already. In numerous EM currencies gold has in fact attained new all time highs, but even priced in major developed market currencies the performance of the gold price continues to diverge significantly from that in USD terms.

 

4-Gold in yen and euroGold in yen and euro. There wasn’t even a bear market in yen terms, merely a correction – and it bottomed in mid 2013. In euro terms the gold price has bottomed in late 2014 and appears to have put in its third consecutive higher low recently. If it manages to exceed its early 2015 interim high, it will be legitimate to speak of a new bull market – click to enlarge.

 

In developed market commodity currencies like the Canadian dollar and the Australian dollar, gold has bottomed in mid 2013 as well and has gained significant ground since then.

As we have remarked in a previous update on the sector, we don’t like it when gold rises for a “reason”, and we found it a bit unsettling that a consensus seemed to have emerged that the gold rally was primarily considered a result of the stock market sell-off.

However, so far it has continued to hold up quite well, in spite of a not overly dovish sounding FOMC statement and a rebound in stocks, so perhaps the gold market is actually beginning to look beyond these presumed correlations. It is a bit too early to judge though – a further short term rally in stocks or in the US dollar may well derail it again.

 

An Update on Divergences

There is one technical development that on the face of it argues for caution. Below is an update of the divergences between the HUI-gold ratio, the HUI and gold. Readers may recall that the last divergence that was put in seemed quite encouraging, as the HUI had failed to confirm a new low in gold. Now a third consecutive divergence has occurred – this time, the above discussed brief breakdown in XAU and HUI was not confirmed by the gold price. However, neither have the two indexes managed to confirm gold’s recent move to an interim high.

 

5-HUI-gold divergencesThe HUI-gold ratio, the HUI and the USD gold price – the series of non-confirmations continues, with the most recent one (illustrated by the red line) normally considered negative – click to enlarge.

 

As we have pointed out in “How to Recognize an Emerging Bull Market”,   usually major turning points are first signaled by strength in gold stocks and only later confirmed by a rising gold price. However, given the strange correlation between gold stocks and base metal mining stocks which has developed in recent years, one should perhaps not be too fixated on the indexes, especially as there are large disparities within the sector – numerous stocks are notably lagging and underperforming, while others are performing quite well.

If one looks at the two gold stocks with the biggest market cap and the greatest liquidity, one actually sees a perfect example of how things should be. Both ABX and NEM have begun to rally well before gold made its low and have built quite decent looking bottoming patterns in the process. Both have not confirmed the new lows in XAU and HUI in mid January. ABX looks especially strong:

 

6-ABX and NEM vs GoldABX, NEM and the gold price – this is a classic bullish divergence – click to enlarge.

 

On the other hand, GG and RGLD are examples of large cap gold stocks with a fairly strong institutional following that have performed very poorly, so on the whole it is a mixed bag.

 

7-GG and RGLDGG and RGLD – two major gold stocks that have performed very poorly – click to enlarge.

 

As we have stressed late last year, bottoming processes in the sector are always tricky (see 1992-93 as a pertinent example). It could well be that things are simply especially tricky this time around. Naturally, we can by no means rule out yet that the rebound is just another flash in the pan – that will only be possible once the HUI actually overcomes its 200 dma and manages to hold above it.

 

South African Gold Stocks vs. the Rest of the Sector

We have discussed Harmony Gold in early December after the company had suddenly paid down a hefty chunk of its debt, and the rand gold price broke out to new highs. We revisited South African gold stocks and the rand gold price again in early January (see “The Canary in the Gold Mine” for details). In the meantime, gold in Rand has surged even further, as the rand up until recently weakened quite a bit more in concert with other EM currencies. As a result this sub-sector has delivered an excellent performance – as the combination of fundamental developments and chart patterns a few weeks ago indicated it would.

 

8-South African Gold StocksThe three South African gold miners that have benefited the most from the weaker ZAR, as most or all their producing assets are located in SA – click to enlarge.

 

However, it seems to us that the time is ripe for at least a short term correction or a consolidation in these particular stocks. If last week’s rebound in oil prices/ industrial commodities and stock markets continues for a while longer, EM currencies are bound to strengthen. As you can see below, the Rand has in fact turned up against the USD last week from extremely oversold levels (shown as “overbought” in USD/ZAR), and the Rand gold price has begun to correct accordingly:

 

9-Rand gold price vs USDZARThe Rand gold price and USD/ZAR – click to enlarge.

 

Keep in mind though that these stocks have historically tended to add to their gains after such an initial correction, even if gold in Rand only proceeded to move sideways in a new, higher range. This may be because some investors only react once the first earnings results reflecting the move in the Rand gold price have been released. So it seems worth keeping an eye on these stocks.

In the meantime, it could well be that certain laggards in the sector are actually poised to do something analogous to what these stocks have done. Consider for instance the ratio of Canadian gold mining form Kinross (KGC) to HMY. It certainly argues in favor of mean reversion. The chart of KGC by itself looks awful – but so did that of HMY when it approached its low. Another important similarity is that the market fails to reflect a number of positive fundamental developments in KGC’s case as well at present (we will discuss this particular stock in more detail in a separate post).

 

10-KGC-HMY ratioThe ratio of KGC to HMY has moved from one extreme to another – perhaps the time for a mean-reversion has now come? Many Canadian gold stocks have been extreme laggards, and in a number of cases it is not quite clear why – click to enlarge.

 

In short, there may be a few opportunities to redeploy funds from one group of stocks within the sector to another group that still appears to have catch-up potential. As an aside, many silver stocks have also been beaten down a lot and may therefore have bounce potential, but as long as economic confidence is weakening, gold should continue to outperform silver, even though silver is historically cheap relative to gold.

 

Conclusion

In spite of the sector continuing to try the patience of investors, a number of positive things have happened lately – but as so often, it is a mixed bag, as a few short term technical warning signs are in evidence as well (see the discussion of divergences above). Whether a sector-wide trend change is in fact beginning remains of course uncertain until certain technical preconditions have been met (such as overcoming lateral resistance levels and the 200 dma).

However, as we have previously argued, even short term rebounds that are subsequently surrendered again are worth playing in this sector due to its enormous volatility (consider e.g. that HMY has rallied nearly 300% between late November and late January; not too many stocks manage to do this in just two months). At some point there will be a sector-wide rally that will turn out to be the “real McCoy” and we will certainly comment if/when that happens. Note as an aside that the fundamental macro backdrop for gold itself has improved of late.

 

Charts by: StockCharts, SentimenTrader

 

 

 

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5 Responses to “Gold and Gold Stocks – A Meaningful Reversal?”

  • Hans:

    A good time for those with a gain or those with a
    serious drawdown, to close their position(s).

    Au will retest it’s low of 1045 this year.

    • All-Your-Gold-Are-Mine:

      The problem with your advice is that you and almost every other person on the planet believe Gold is headed back down to restest the low or even lower… a quick study of history reveals that is how bottoms are made. The bottom is already in… sit back and relax… enjoy the ride for those of us that backed up the truck at the lows!

      • Hans:

        AYGAM, we shall see. There is little in terms of any current
        financial crisis or instability which will drive buyers to bid up the metal.

        I do believe Au time will come again but that could be some
        four years down the road.

        BTW, from 2006 to 2012, my principal stock holdings where
        in Au and Ag.

  • sriechers:

    Add HUI and GDX to the list…

  • The gold paper share market (GLD) is sporting serious gaps…

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