Gold Stocks Slide as USD Index Strengthens – Should You Be Concerned?

The precious metals market is correcting. In my previous essay, I summarized that it seems that gold, silver, and corresponding equities need to take a breather to correct their post-$1,000-breakout rally. This is what we’ve seen lately, so the question is how low can we go and what to look for as signs of a reversal.

Precious metals (PM) stocks have been hit particularly hard in the past several days, so this week I would like to cover the situation in this important sector.

The mining stocks sold off heavily in the past two weeks but have now reached significant support levels and the technical situation is now once again favorable. The GDX ETF (proxy for PM stocks) has just reached the 50% Fibonacci retracement level and bounced with a vengeance, which by itself makes it probable that the bottom is already in. GDX closed at $43.80 on Thursday, right at one of the support/resistance lines.

Two of the popular indicators suggest that a bottom is close or already in. The RSI Indicator has just bounced from the lowest levels since the October 2008 low. In other words, according to this tool, the precious metals stocks present a buying opportunity not seen since then.

Another indicator that has been useful in the past in timing bottoms in the PM stock sector is the Stochastic Indicator. It is clearly below the 20 level – at the blue horizontal line – which marked a great buying opportunities in the past.

Were that not enough of bullish signals, the more detailed analysis of the previous breakdowns provides us with one more confirmation. Please note that breaking below the previous support lines drawn from the October 2008 bottom (marked with dashed lines) means that the decline was more or less 50% complete. That is the case also today, which suggests that even if we were to move lower from here, the second bottom of the double-bottom formation would not be much lower.

But wait - there are even more PM-stock-bullish signals. The following one comes from our own indicator that I designed to detect favorable buying opportunities.

According to the current value of the SP Gold Stock Bottom Indicator (relative to the dashed horizontal lines), we are right at or very close to a local bottom.

Speaking of short term, let’s take a look to the short-term chart of GDX ETF and see if it provides us with additional timing details.

As I mentioned above, the current downswing has just touched the 50% Fibonacci retracement level, and that the value of the GDX ETF dropped below the long-term support line more or less by the same about that it declined before reaching it. The top was at $49.8, and the price broke the support line at $45, so in fact the move will be symmetrical (relative to the support/resistance line) if GDX moves lower to about $40-40.5. This would correspond to the 61.8% Fibonacci retracement level – clearly strong enough to hold, given the rapidness of the decline (the more rapid a move is, the more “emotional” it is, and consequently more prone to be correctly predicted using the technical analysis).

Does it have to move lower because of this symmetry? Of course not. Similar events took place in the past and history often rhymes, but again, the symmetry was not very precise back then, so I would expect it to work on a “more or less” basis also here. This implies that it is quite possible that we would move to the $40 level, but it is not very probable.

There is one more chart that I would like to feature before summarizing – the Gold Miners Bullish Percent Index.

I featured this interesting tool back in June (which marked the bottom marked on the chart above), and since the situation (as far as the above chart is concerned) is very similar to the present one, I will quote what I wrote in the June 20 update and edit it to make it correspond to today’s situation.

The Gold Miners Bullish Percent Index is a market breadth/momentum indicator and is calculated by dividing two numbers: the amount of gold stocks on the buy signal (according to the point and figure chart, which emphasizes strong moves while ignoring small ones) and the amount of all gold stocks in the sector. If every gold stock is rising, then the value of the index will be at 100%, which raises a red flag as everyone interested in the market is already in, and the top will soon emerge. If we're looking at sentiment, substantial momentum usually corresponds to investors eager to jump in at quickly rising prices because they believe prices will continue much higher and are afraid of being left behind. If we said that at 100% the indicator shows overbought conditions, then you can see on the above chart that at the current 61% level the indicator is not extremely overbought, nor is it oversold. The Gold Miners Bullish Percent Index is no longer signaling that lower prices are to be expected, which was the case several weeks ago. Since the value of the index does not need to be at the oversold levels for a local bottom to form (still it is helpful in timing the major bottoms), we might need to look for additional tools to help us.

If you look closely you will notice two such additional tools in the above chart. The RSI (Relative Strength Index) is a technical momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions.

The RSI also ranges from 0 to 100 with an asset deemed to be overbought once the RSI approaches the 70 level, meaning that it may be getting overvalued and is a good candidate for a pullback. Likewise, if the RSI approaches 30, it is an indication that the asset may be getting oversold and likely to become undervalued. If you look at the RSI indicator in the above chart, you can clearly see that it in fact just moved below the 30 mark.

Another indicator on this chart is the Williams %R, also a momentum indicator that is especially popular for measuring overbought and oversold levels during horizontal trends. Bullish percent indexes take values from 0% to 100% and obviously cannot rise above that level, so it can be viewed as a horizontal trend. Named for its developer, Larry Williams, the scale ranges from 0 to -100 with readings from 0 to -20 considered overbought, and readings from -80 to -100 considered oversold. What I find particularly interesting here, is that the %R indicator has signaled a "temporary oversold" territory only three times in 2009 - and that corresponded to the long-term buying points, and powerful rallies. The last time the %R indicator for Gold miners Bullish Percent index hit the -100 level was during the September bottom - a sizable rally followed. The same signal has just appeared in the recent days, which suggests that we will see PMs higher in the not too distant future.

Currently both RSI and William’s %R indicators suggest that a bottom is in or very close.

Summing up, the fundamental situation is still favorable for the precious metals market, and the main trends remains up. The medium- and short-term technical situation is very favorable for the precious metals stocks. The problem is that in today’s globalized economy and even more globalized financial markets, no asset class or market exists without connection to other markets. In case of the precious metals market, it is the general stock market, and – most of all – the USD Index that need to be taken into account while estimating future price swings.

In other words, although the situation on the precious metals market is itself very bullish, the situation on the key driving markets is may pose a serious threat to PMs, because of their historical correlations.

Disclosure: I own gold and silver.

Comments

[The Geoffster]

As people wake up to the fact that their government is deliberately debasing their currency, they will purchase gold and silver as stores of value. Most people still don't realize that the dollar is just paper and gold and silver are real money. As they watch their purchasing power diminish, they will flock to PM for safe haven.

2009 Oct 31 04:32 PM

[BullnBear]

Nice data, I believe that the U.S. dollar strength/weakness is going to be the key for not only precious metals markets but the energy markets as well.

2009 Oct 31 06:02 PM

[optionsgirl]

Ag, too.


On Oct 31 06:02 PM BullnBear wrote:

> Nice data, I believe that the U.S. dollar strength/weakness is going
> to be the key for not only precious metals markets but the energy
> markets as well.

2009 Nov 01 01:49 AM

[tipalia]

...and what is the only possible way to pay back an immense debt ?
Actually there are 2 ways, declare bankruptcy or devaluation of the currency . We should all know what happened in the past , isn t it ?
If you don t learn from the past you deserve where you are now .
Protect yourself from what is coming .

2009 Nov 01 10:23 AM

[Clint007]

For me the Tech. analysis is much lower in importance then the adding information about this awful US economy. The more negative economic news= more bullish for Gold.

So, the TA is a complement to information.

2009 Nov 01 10:33 AM

[HATEFEEBAY]

As I watch the massive stability of silver and gold prices and how the mining equities fall-it is crazy! I own JAG and SLW and as thiey fell this week, instead of selling, I purchased a lot more. If it falls again, I will even purchase more too. I have ZERO confidence in the governments anymore...

2009 Nov 01 10:46 AM

[realold]

This analysis is very interesting, but it seems to me that your conclusions are what you want them to be. Just looking at the charts, it could be said that GDX has broken through resistance and is free to fall much further. Statistics as usual.

2009 Nov 01 11:01 AM

[Mr. G]

It is fairly obvious that gold and oil are trading inverse to the dollar index. Looking at the dollar index, It is still in its downward trend technically, but if it goes higher this week, gold and oil could break more to the downside, and the dollar could be bottoming which would be be a bigger reason to wait on the sideline till a more positive direction for the dollar is determined. The key is to watch the US fundamental readouts this week. The chopiness in the market may be resolved if the US economy committs to one side or the other.

2009 Nov 01 12:06 PM

[The Recusant]

The inverse correlations of the dollar to gold indexes is the current norm. However, although inflation is nearly guaranteed to follow by the end of next year and thereafter, it may not be quite as bad as many assume. We are still in the stage of massive mortgage and credit card defaults. Banks may recover only 6% to 10% of their initial loans, the rest might be destroyed by the defaults, reducing the huge liquidity caused by the quantitative easing (money printing) of the government. Trillions could vanish by the time the defaults are finished and act as a giant-slayer to the prospects of hyperinflation. Yet investing in gold, and gold miners, will still provide not only the safe haven that all are seeking, but a likely increase in investment when at least that nominal inflation begins. The final trick will be to know when to get out of gold at its peak before everyone begins a sell off and drives the price back down in that distant future. But that's another story.

2009 Nov 01 05:18 PM

[Mr. G]

I have traded the forex for some time and watched the gold bugs predict $2000 gold over 2 years ago only to see it go much lower. When gold drops, it tanks. Notwithstanding the current account deficit we can see, the US economy has unbelievable resilience. Just ask Gates and Buffet when they lost a billion or so from a previous current account read..I admit the situation is not bright, but caution is always advisable when playing real money. Keep your eye on the unemployment rate next friday. It is a heavy hitter and if it drops, you might be surprised. If it goes higher, I would say the long in gold is still on the table.

2009 Nov 01 05:45 PM

[LaChic]

I agree with the author...

2009 Nov 02 07:59 AM

[metakid]

Yep, agree that the weaker dollar is surely going to help the energy market. There was a CNBC panelist (www.newsy.com/videos/w...) that said that gold has "already rallied a lot out of its function as a recession hedge over the course of the last year or so." Time to look at oil and the energy markets?

2009 Nov 06 12:55 PM