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The Fundamental Backdrop is Still the Same, But …

The FOMC statement was once again almost a carbon copy of the last one. The only noteworthy event worth commenting on is that in addition to the hawkish dissenter Esther George, John Bullard dissented because he felt the Fed's actions are not dovish enough (he's worried about 'inflation being too low' of all things).

Still, it is the market reaction that counts, and nearly all markets except the dollar reacted rather badly to Ben Bernanke's news conference – even though it actually contained no news. Treasury yields soared, stocks were whacked, and so was gold. When we last wrote about gold and gold stocks we remarked:

“Unfortunately the HUI index violated the previously highlighted gap support in Tuesday's trading, which killed the 'island reversal' idea (it did however revive the idea that all upside gaps in the index tend to eventually be closed). It was especially worrisome that this happened with gold relatively stable, i.e., the HUI-gold ratio once again went into the 'wrong' direction. Per ample experience that is a sign that gold is set to decline further in the short term (we are always open to surprises on that front, but those are rare).

Gold itself is conspicuous by its utter failure to profit from recent weakness in the US dollar. This is a bearish sign as well.”

(emphasis added)

That has indeed turned out to be the case. While neither gold nor the HUI have as of yet broken to new lows, the charts certainly don't look good in the short term. It should be pointed out though that investors with a longer time horizon probably won't make a big mistake by buying on weakness. However, in the short term all the tentative evidence that a bottoming process may be under way has by now been eradicated.

The negative short-term factors discussed in the last update continue to hold sway.

Gold has now formed a descending triangle, and it is worrisome that gold in euro terms has already fallen to a new closing low, which means that the equivalent triangle in gold/euro is in the process of breaking down (the break is still very small, so it may be reversed, but we'll only believe that when we actually see it).

Below are several charts illustrating the situation. Interestingly (oddly in fact), gold has also built a descending triangle relative to the CCI. This is odd because economic activity around the world looks very anemic, and usually gold tends to rise relative to commodities in such an environment.

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A descending triangle on the daily gold chart

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Gold in euro terms looks actually slightly worse. It has been a leader to the upside since 2005, is it now a leader to the downside?

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The gold-CCI ratio – the descending triangle is in evidence here as well

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If one looks at a comparison between gold and the dollar index, one can see that gold lately fails to react to dollar weakness, but reacts violently whenever there are signs of dollar strength.

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The U.S. dollar versus gold (green line) – gold declines whenever the dollar shows strength, but it fails to rise much when the dollar weakens. This continues to be negative sign

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Gold Stocks

As noted above, the gold stocks have once again been leading to the downside, and have moreover confirmed the recent weakness in gold. The best thing that can be said about the HUI's daily chart is that a break to new lows would produce yet another momentum divergence (this is to say, a price/RSI, and price/MACD divergence).

As we have pointed out before with regard to the statistics provided by James Debevec in the context of past instances of gold stocks reaching long-term 'oversold' extremes, there has been further short-term weakness in gold stocks in all cases but one when a long-term 'buy signal' was given. It may be worth contemplating the table showing the previous occurrences again:

Debevec20130603p5

James Debevec's table of previous long-term 'oversold' buy signals in gold stocks. Here is his article on the phenomenon that provides additional color.

This is one of the reasons why we are saying that long-term oriented investors probably won't make a mistake if they decide to buy on weakness. There would likely be a few more weeks of soggy action, but interestingly, the bigger the short-term drawdown was in previous cases, the bigger the subsequent rally turned out to be as well.

Since the current correction is reminiscent of the 1970's mid cycle correction, we may see comparable weakness before a turning point is finally reached.

That said, in the short term, the charts certainly don't look particularly confidence inspiring – as it appears now that the recent back and forth was not a bottoming formation, but rather a continuation formation. There is of course still a chance that a double bottom may be about to form in the HUI, which if it is to happen, must happen more or less immediately:

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The HUI is weakening again and the putative bottoming formation is beginning to look like a continuation formation. However, yet another price/RSI divergence is likely to be recorded if new lows should be made

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There is also nothing positive to report in terms of the HUI-gold ratio at this point in time – after an attempted breakout to the upside, it has reversed very quickly again and is back at its previous low:

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The HUI-gold ratio and gold (green line below) – the ground that has recently been gained has been given up again just as quickly

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Conclusion

None of these charts look positive in the short term. A potentially bullish island reversal in the HUI has been negated, gold has built a descending triangle, and both gold and gold stocks are very close to breaking though near-term support. In order for the short- term picture to remain at least 'undecided', these support levels must hold – a possibility that can of course not be ruled out. It should become evident fairly soon whether that will happen or not.

It continues to be of concern that dollar strength begets weakness in gold, but dollar weakness fails to beget strength in gold. As a result of this, gold looks even weaker in euro terms than in dollar terms – and gold in euro terms has been a leading indicator for the dollar denominated gold for some time.

We continue to believe that the long-term picture has not been altered by this downturn, in spite of how extensive it has turned out to be. Similar declines could be observed on two occasions in the 1960-1980 bull market in gold stocks (in both instances, namely 1969 and 1974-1976, gold stocks as measured by the BGMI plummeted between 60% to 70%). Moreover, gold stocks are at their weakest relative to gold since early 1942.

June is a seasonally weak month for gold. It could therefore be that the current weakness is only transitory, and that things will begin to look better beginning next month. Gold's behavior in the seasonally stronger period should actually provide us with additional clues.

Charts by StockCharts, table by James Debevec

Source: Gold And Gold Stocks, Post FOMC Update