Gold Technicals

By: Adam Hamilton | Fri, Apr 8, 2011
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Gold has much to celebrate. Not only did it just hit new all-time nominal highs, its secular bull was born exactly 10 years ago this week! It's enough to bring a tear to the eye of the bold contrarian investors who've been riding this mighty bull market for an entire decade. Much has changed since I first started recommending physical gold coins as long-term investments in May 2001, when gold traded at $264.

A decade later and we're on the verge of $1500, a once-unimaginable number. During a horrendous secular-bear decade in the general stock markets where the flagship S&P 500 stock index only gained 16.6%, gold soared 469.3%! Never having a single down year, the Ancient Metal of Kings has no doubt been the best investment of the past decade. And its global supply-and-demand fundamentals remain very bullish today, its secular bull is far from over.

But all bull markets, including gold's, flow and ebb. Massive uplegs are followed by sharp corrections. These short-term trend changes create great opportunities for speculators and investors alike. Upleg tops offer ideal times for speculators to realize short-term gains, and the subsequent correction bottoms generate the best buying opportunities for both speculators and investors to deploy more capital. So how are gold's near-term technicals looking today?

The short answer is pretty good, although there are mixed bullish and bearish factors that will probably influence gold in the coming months. Gold is neither oversold nor overbought today, not too low and not too high. It is just advancing nicely within a strong uptrend that has persisted since the end of late 2008's crazy stock panic. Gold's chart, which distills all relevant technical price action, continues to look healthy.

In this gold chart I built this week, the usual gold technicals including moving averages and standard-deviation bands are slaved to the right axis. The left axis shows how gold looks in terms of my Relativity trading system, which has been essential for helping us and our subscribers ride this gold bull to massive trading gains. It expresses gold as a multiple of its baseline 200-day moving average, a construct that meanders in a horizontal trading range over time.

Gold Technicals Chart

Ever since the stock panic climaxed, gold has been powering higher in this strong post-panic uptrend. It has rarely exceeded its upper resistance and never fallen materially under its support line. This is a textbook-perfect uptrend, with gold advancing well beyond its 200dma in uplegs and correcting back down to its 200dma in corrections. Gold's behavior has been similar for its entire decade-long secular bull.

If you divide the blue gold-price line by its black 200dma line, the light-red Relative Gold (rGold) line is the result. It is like flattening gold's 200dma line to horizontal, and then rendering where gold is trading relative to it in perfectly-comparable percentage terms. This rGold indicator has formed a horizontal trading range running between 1.00x on the low side to 1.25x on the high side. In other words, gold almost always meanders between its 200dma (1.00x) and 25% above it (1.25x).

Trading gold is simple, buy when it is near its 200dma and then sell when it stretches too far above it. Back in early December 2009 gold rallied too far too fast and thus became overbought, hitting 1.25x on a relative basis. This sparked enough greed to suck in all traders interested in buying gold at the time, which left only sellers. So gold soon corrected sharply after being so overbought. Prudent traders sell when rGold balloons to overbought extremes.

Conversely, in late July 2010 gold fell to within 2% of its 200dma in the usual summer doldrums. This was a fantastic time to buy technically. Largely due to this 200dma approach, not long after that I predicted a big autumn gold rally in the coming months. And indeed as expected, gold surged dramatically. When gold nears its 200dma, all the traders interested in selling anytime soon have already been driven out. Excessive fear leaves only buyers, so gold soon rallies in its next upleg.

Even simpler, gold can be bought when it is near its uptrend's support line and sold near resistance. Note that gold was above resistance at its late-2009 topping and slightly below support at its mid-2010 bottoming. Later last year gold's autumn rally carried it back up near resistance where its advance soon slowed. After once again topping in early December 2010, gold actually started correcting in January 2011.

And this is where gold's technicals start getting really relevant to today and the next couple months' outlook. In 7 weeks leading into its late-January low, gold had corrected 7.8% in a nice healthy bull-market correction. Yet this correction wasn't quite mature yet when gold bounced, this metal was still well above its 200dma and uptrend support lines. Gold had been approaching oversold levels, but hadn't hit them yet.

That late-January bounce was driven by an extraordinary geopolitical event. After the US markets closed the afternoon before, Egypt's government severed Internet access for its 79m people. The next morning, CNBC started running extensive riot footage out of Egypt. This led to intense anxiety that drove the biggest stock-market down day since mid-August. Gold surged 1.8% on these geopolitical fears.

And ever since that prematurely-interrupted correction, gold has been climbing higher and seldom looking back. Unfortunately since it never got truly oversold before this catalyst sparked its latest rally, its sentiment wasn't fully rebalanced. Not enough traders were frightened away, fear didn't get high enough. This left a weaker sentimental foundation for today's rally, reducing its ultimate potential.

Just like gold never really grew oversold in late January, it has yet to grow overbought in this rally. Measured especially in terms of its relationship to its 200dma, as well as within its simple uptrend channel, gold is not overbought or excessively high today. This means technicals and sentiment don't yet stand in the way of gold's advance continuing. And indeed seasonal factors argue for gold buying persisting.

Due to large fluctuations in gold demand that follow the calendar year, this metal actually exhibits strong seasonal tendencies. My latest essay on gold seasonals illustrates all of this in depth. Seasonally, April and May are strong months for gold. On average in this secular bull, gold has rallied 4.1% between late March and late May. If these seasonals hold true again this year, gold has another 6 or 7 weeks to extend this rally. This probable outcome wouldn't surprise me one bit.

After it typically peaks in late May though, gold enters the brutal summer doldrums. June and July, and sometimes August, are always the weakest time of the year for precious metals. There are no cultural factors like Asian festivals to drive gold demand spikes in summer, and many traders are vacationing and not particularly interested in the markets. So like usual in early April, the best we can hope for seasonally is for gold to rally into late May before it starts drifting lower again into early August.

While we have capital deployed in gold stocks because of this seasonal-rally tendency and the fact gold isn't overbought yet, other factors are near-term bearish for gold. This metal is nowhere near its 200dma and support, so it would be foolish to be unreservedly short-term bullish. The biggest risks for gold in the next couple months actually come from the overbought general stock markets!

The stock markets have been very overextended for a couple months, riddled with extreme complacency and greed and very overbought technically. A real full-blown correction is overdue to rebalance sentiment, far beyond the recent minor 6.4% pullback that bounced in mid-March. Falling stock markets create problems for gold on a couple key fronts.

First, stock-market corrections (and even major pullbacks) spark a worldwide surge in anxiety and fear. This leads foreign stock traders to not only sell their local stocks, but then sell their local currencies to park capital in US dollars. This safe-haven currency demand drives big US dollar rallies coinciding with the stock-market weakness. Stock selloffs igniting dollar rallies have been seen every time since the panic that falling stock markets generated any meaningful fear. And when the US dollar surges, futures traders dump gold.

As the ultimate currency for six millennia of human history, gold is and always has been money. Thus it tends to trade like a currency when the foreign-exchange markets are experiencing big moves. All the biggest and fastest US dollar rallies of the last few years have coincided exactly with stock-market selloffs, and thus indirectly the stock-market selling has really weighed on gold. A new stock correction today would almost certainly lead to similar selling pressure hammering this metal.

Falling stock markets also have a universal bearish psychological impact. The fear and anxiety they spark lead traders to sell all risky assets, which is known as the "risk-off trade". And somewhat surprisingly given its long safe-haven history, gold is considered a risky asset today. While I don't agree with this, the fact is traders are still lumping it in with other commodities and selling them all when stocks are weak. So gold faces heavy psychological splash damage, and selling pressure, during stock-market corrections.

This sentimental link is greatly exacerbated by the gigantic GLD gold ETF. This immensely-successful trading vehicle enables stock traders to get direct exposure to the gold price. It acts as a conduit for the vast pools of stock-market capital to flow into and out of physical gold. So when falling stock markets weigh on universal sentiment and traders start selling risky assets to reduce their capital at risk, GLD can be sold as well. And if this ETF's shares are sold at a faster rate than gold, it drags down gold with it.

This next chart looks at GLD's physical-gold-bullion holdings compared to the gold price. In order for any tracking ETF to work, its custodians have to shunt excess buying and selling pressure directly into the underlying asset. So when GLD's holdings are rising, demand for GLD shares exceeds demand for gold. In order to keep GLD from decoupling to the upside and failing its tracking mission, its custodians issue new shares and use the proceeds to buy gold bullion. Stock demand is shunted into physical gold.

But this conduit is a double-edged sword. When GLD experiences differential selling pressure compared to what gold itself faces, this ETF will decouple to the downside. To prevent this, GLD's custodians have to sop up the excess GLD share supply. They raise the funds to buy back shares by selling some of this ETF's gold bullion. Thus excess selling pressure in this ETF is shunted into gold itself, driving down its price. With this critical dynamic in mind, take a look at GLD's holdings lately.

Gold and GLD Holdings Chart

GLD's gold bullion held in trust for its shareholders offers a window into how stock traders feel about gold. Rising GLD holdings mean stock-market capital is flowing into GLD and thus into gold. Falling GLD holdings reveal capital flowing out of GLD, money raised by this ETF selling bullion. These flows are great for gold at times like early 2009 when major hedge funds bought aggressively. But when stock traders want to exit gold for any reason, like being worried about risk, GLD selling weighs on gold prices.

In 2009 and early 2010, GLD holdings generally rose when gold was rallying. This makes sense, as everyone gets more excited and enthusiastic about an asset with a rising price. And then when gold corrected after these advances, stock traders generally held onto GLD anyway. There wasn't significant selling pressure, this ETF's holdings were "sticky" as stock-market traders believed in gold's long-term potential.

Unfortunately though, in mid-2010 this bullish model started to break. Despite the big autumn gold rally last year, GLD's holdings drifted lower. This means stock traders were buying GLD at a slower rate than gold was being bought, forcing it to gradually liquidate holdings to equalize the differential demand. And then when gold started correcting in January, GLD's holdings fell rather sharply. Stock traders sold GLD shares much faster than gold was being sold, which has been very rare in GLD's 6-year history.

On top of this, GLD's holdings continued drifting lower despite gold's recent rallying since late January! This is very odd, stock traders either aren't interested in gold or don't believe its current rally has staying power. Together all these developments since last summer have led to the weakest trend we've seen in GLD holdings since this ETF was born. This can't be a good omen.

Given the fading stock-trader enthusiasm for gold exposure, the probabilities are as high as they've ever been that GLD shares will be sold aggressively in any stock-market correction. It has been so long since any real fear was seen in the stock markets (last summer) that it ought to flare quickly when the next correction accelerates. This will lead to very bearish universal psychology and put tremendous pressure on traders to de-risk their portfolios by selling commodities, including gold.

So between the likely US dollar rally and deteriorating GLD holdings, the bearish sentiment spawned by a stock-market selloff has a much greater chance than usual of spilling into gold. If this stock-market correction continues to tarry, gold's bullish seasonals should exert themselves in the coming weeks. But if the S&P 500 finally starts falling, I suspect gold will be hard-pressed to avoid getting sucked in.

While gold certainly isn't overbought in a technical sense today, the interplay between its seasonals and the increasingly-likely stock-market correction's impact can't be dismissed. This metal looks bullish in the near term, but guardedly so. Its last correction was cut short so sentiment wasn't properly rebalanced, which leaves this rally with less potential than usual. Still, on average gold tends to perform quite well in April and May.

At Zeal we're playing gold cautiously today. We have some gold-stock trading positions outstanding, but nowhere close to a full deployment. That will come after gold weathers this year's summer doldrums and is driven back down to its 200dma. But nevertheless we are continuing our fundamental research as always, trying to discover the highest-potential gold stocks to buy when the timing is right. Our latest 3-month deep-research project dug into the wild and risky world of junior gold stocks.

Starting with around 500 junior golds trading in the US and Canada, we spent several-hundred painstaking hours whittling this list down to our dozen fundamental favorites. All are new stocks we've never profiled before, and are each explored in depth in our fascinating new 26-page report. If you are interested in high-potential junior golds, you'll love this fundamental research. This valuable fruit of 3 busy months of expert labor is now available on our website for just $95 ($75 for subscribers). Buy yours today!

We also publish acclaimed weekly and monthly subscription newsletters. They funnel all our research, knowledge, and wisdom towards our mission of profitable real-world trading. In them I explain what the markets are doing, why, and what is likely coming next. When the odds for success grow favorable, we launch real-world trades you can mirror with your own capital. Since 2001, all 583 of our newsletter stock trades have averaged annualized realized gains of +52%! Subscribe today and start thriving!

The bottom line is gold's technicals look pretty good today. Despite its recent rally, this metal isn't anywhere close to being overbought yet. And heading into one of its seasonally-strong periods of the year, it has plenty of potential to continue advancing. But the big wildcard is the stock markets, which themselves are very overbought and due to start correcting any day. This would weigh on gold.

Stock-market corrections drive sharp US dollar rallies, leading futures traders to dump gold. And thanks to the direct conduit for stock-market capital the GLD ETF created, a correction's risk-off psychology can now spill directly into gold. And given what GLD's recently declining holdings signal about waning stock-trader interest in gold, today's stock-correction spillover risk is much higher than usual for this metal.

 


 

Adam Hamilton

Author: Adam Hamilton

Adam Hamilton, CPA
Zeal LLC.com

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Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing delivered from an explicitly pro-free market and laissez faire perspective. Please visit www.ZealLLC.com for more information, www.zealllc.com/samples.htm for a free sample, and www.zealllc.com/subscribe.htm to subscribe.

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