Update On Gold: Is This The Bottom?

by: Dave Kranzler

I wanted to update the indicators I like use that have historically signaled a market bottom after a severe price correction in the precious metals and mining stock sector. Clearly, my previous suggestion that a bottom might be in was a bit early. Quite frankly, I have never observed anyone who has been anything more than occasionally lucky in timing market tops and bottoms over the long run, especially in volatile market sectors like the precious metals.

Since my last post on this topic, both the fundamental and technical indicators I like to use have become even more extreme in their signaling of a bottom to this long, extended price correction.

One of the best indicators in my view is the long/short positioning of the big banks, hedge funds and small speculators on the Comex. Over the past 12 years, when the big banks ("commercials") have a very low relative net short position and the hedge funds/small specs have a very low relative net long position, it's marked a bottom for gold/silver.

The chart below, sourced from SentimenTrader.com via the nightly GATA Midas report, shows the price of gold vs. the net long/short Comex futures positions of the Commercials (bank market makers), the Large Specs (hedge funds) and the Small Specs (small retail account traders), the green circles are my edits:

(Click to enlarge)

As you can see, in 2008 the relatively extreme low net short position of the Commercials (scale is negative denoting a net short position) AND the extreme low net long position of the Large/Small spec correspond with the absolute bottom of the 2008 severe sell-off (a little over 30%). Currently, the net positioning of these trader categories is similar to what they were in 2008.

In fact, the Small Spec category is currently net short the gold market. In order to verify this, I had to refer to the Disaggregated Commitment of Traders Report and look at the "non-reportable" category, which is the small retail trader. Not only is the small retail trader net short, but the last time this category of trader was net short was in 2001. Obviously 2001 is considered the beginning of the bull market in precious metals. The same relationships hold true for the silver COT report, except the Small Spec is not net short at this point.

The second indicator I like to look at is sentiment. There are a few different sentiment measuring services. The first one I like to look at is the Market Vane Sentiment Survey (SentimenTrader.com, linked above). Market Vane tracks the buy and sell recommendations of leading market advisors and CTAs (Commodity Trading Advisers) relative to a particular market.

We subscribe to a service that provides the Market Vane "Bullish Consensus" reading for gold and silver every day. Historically, readings in the high 70's would be considered extreme bullish levels - and therefore bearish as a sentiment indicator. Conversely, readings in the high 40's to low 50's would be considered extreme bear readings, and therefore bullish (these levels are specific to silver). Just a few days ago, the reading for silver had dropped to 38%. This is a multi-year low going back to at least through the beginning of 2004. For comparison purposes, the low reading at the bottom of the correction in 2008 was 49. The author of the newsletter to which we subscribe commented: "I have no doubt that this is a major multi-year bottom - the issue is staying alive to benefit."

Clearly the Market Vane silver sentiment index is flashing a strong bullish signal, from a contrary indicator point of view. The second sentiment indicator I like to use is the Hulbert Gold Stock Newsletter Index, which measures the long/short recommendation from a universe of stock newsletter services. I have the daily readings for this index going back to early 2000. Extreme high bullish readings - and therefore a bearish signal - are in the high 70's. Extreme low readings (bullish signal) are in the negative 30's. A negative reading means that the newsletters are net short. Negative readings are rare over the past 12 years, and negative readings above single-digits are extremely rare. Below is a chart that I sourced from Ed Steer's Gold and Silver Daily report:

(Click to enlarge)

As you can see from this chart if you enlarge it, the rare and extreme readings in negative 20/30's have been associated with market bottoms going back June 1996. Currently the reading is at -25 and it has been at that negative reading level for a couple of weeks. In other words, not only are 25% of market newsletter which cover the mining stock sector short, but this level of shorting is statistically extreme and it has been this extreme for a record period of time. I'm not sure a sentiment indicator can possibly be more contrarian, and thus represent a market bottom.

Finally, in what I would consider a very strong signal about the prospects for the mining stocks, it was recently reported by a service that monitors insider stock transactions that insider buying of junior mining shares has reached a record high of 1,305%, meaning that over the last 30 days there have been more than 13 insiders buying their company's shares for every 1 seller. The article states that high levels of insider buying in junior mining shares in the past has correctly foreshadowed a move higher in share prices: INK Research Venture indicator.

In twelve years of researching, investing in and trading the precious metals and mining stock sector I have never seen the indicators which I follow for bullish/bearish signals register readings this extreme and thus this bullish. That's not to say that this market won't grind sideways for a bit longer. In 2008, it took a little over six weeks after the market had bottomed for it to consolidate and begin to move into a bull cycle that took gold, silver and the mining stocks to new record highs over the next 2 1/2 to 3 years.

If you agree with my assessment, the best way to start taking advantage of the opportunity presented by the market is to initiate, or add to, physical gold/silver bullion holdings. I prefer any 1 oz. sovereign-minted bullion coin (silver eagles, maples leafs, Austrian philharmonics). Once you've collected some bullion that you keep in your safekeeping, you can create trading plays on gold and silver with the GLD and SLV, and leverage trading plays on gold/silver with the DGP (2x gold)/AGQ (2x silver) ETFs. I prefer these two leveraged trusts because they are the most liquid of the leveraged metal ETFs and AGQ has options that also have good liquidity. With the mining stocks, if you don't have time to do proper research/due diligence, you can index the mining stocks with GDX, GDXJ and NUGT (3x the HUI index).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I am long physical gold and silver. The fund I co-manage is long physical gold, silver, mining shares, AGQ and options on AGQ.