Gold Is Getting Overbought

By: Michael Swanson | Thu, May 4, 2006
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Today I browsed half a dozen of the largest financial websites on the internet. Almost every single one of them had an article about the gold bull market. At the end of the day, on Fox News, I continued to shake my head as I saw Tobin Smith make bullish comments about gold stocks. A year ago, in case you don't remember, he was laughing at them.

If you've been a member for a while you've certainly heard me mention that this many people making bullish comments about a market (gold or whatever) must be a sign that the top is near.

But here's the difference. Last year, we were in phase one of the gold bull market. Now we seem to be in phase two and in phase two people can be bullish and the market can continue higher. We certainly seemed to be going higher now. The dollar is showing signs of re-entering its bear market, which will provide a further catalyst for gold purchases, while worries about Iran, inflation, and higher oil prices are also putting a prop underneath the market.

However, even in bull markets you get pullbacks. And there are some important signs that we are on the verge of a pullback in gold. First, after rallying over 130 points since March 10, gold has simply become overbought. Although we got a little bit of a dip in April, we have not seen gold digest these recent gains. At some point it will need to in order to move higher.

Secondly, gold stocks are starting to lag the metal. Yesterday gold closed up 13 points and many of the large cap gold stocks finished in the red. Most of the others were barely up at all. The XAU gold stock index finished the day up 1% while gold closed up 2.1%. If this trend continues today I will be very worried about a correction.

For the past week, the XAU gold stock index has been lagging the metal. While gold has rallied like mad, gold stocks have barely followed suit. This is the type of setup in the past that has led to intermediate-term corrections lasting several months. Indeed this type of action led me to sell most of my gold stocks back in December. But things turned out to be different back then to clue us in that we are now in a stage two bull market.

Over the next few weeks I expect the metal to pullback and provide an entry point in the gold stocks. We have two recent pullbacks that can provide a model for what might happen. Back in December, the XAU lagged gold as gold blasted higher and made what appeared to be a parabolic top at the time. That action accurately warned that a correction loomed. And it came, with gold falling almost 90 points and back below 500. However, gold stocks held up during that drop and gold snapped back and rallied into the end of the year.

If a similar move were to happen here we would see the XAU quickly pull back to the 146-150 area while gold falls into to its 580-520 support zone.

Another type of correction is the one we saw occur in February and March. That would be a more serious correction that would cause the XAU to fall about 15%. We saw corrections like this occur repeatedly from 2001 and 2005 when gold was in stage one of its bull market.

I think the first scenario is more likely. Either way, I'm going to make a dozen or so gold stock recommendations once we get a safe entry point in gold stocks.



Michael Swanson

Author: Michael Swanson

Michael Swanson,

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