Gold Sentiment: Going Parabolic

May.18.10 | About: SPDR Gold (GLD)

Last week I couldn’t resist the temptation to weigh in on gold and how it is going parabolic - this time in Euros, instead of US dollars. The price of gold has been reaching for the sky in almost every currency but the catalyst is no doubt, the European sovereign debt crisis. Greece and in turn the EU is boxed in.

Unlike the US or China, they can’t spend their way out of this crisis, they can’t borrow their way out of it and austerity measures, even if actually implemented in spite of riots, will shrink the economy and make debt servicing that much more difficult. The end game is dire indeed.

Not surprisingly then, last week the DSI for the Euro plumbed depths not seen for more than 10 years when it hit 2%. That means that a paltry 2% of retail investors have confidence in the Euro. That’s a lot of skepticism, bordering on outright paranoia. I’ll give you that the Euro has crashed to levels not seen since early 2006. But when the Euro made a multi-year low in late 2005, the corresponding DSI for the currency was 6% (mid-November 2005). That was still 3 times as high as now and the Euro is actually trading higher now than it was then.

Does anyone else get the distinct impression that long gold, short Euro has become the trendy trade-du-jour? Usually when emotionally charged markets get this lopsided and pushed so far to one side we see a sharp counter-trend rally. So I wouldn’t be surprised to see that although no market has to follow the dictates of a sentiment indicator like the DSI.

Gold Sentiment
Turning to the sentiment picture in gold, things are decidedly more murky. In the futures market the open interest spiked up to a new all time high for the commodity. While some believe this to be a contrarian measure, it is probably just a reflection of the strength in the market and if this is a secular bull market, the shattering of such records is par for the course.

Remarkably, two gold sentiment surveys show an actual reduction in optimism even at this high. According to the Hulbert Gold Newsletter Sentiment index, which measures a subset of gold stock newsletters that time the market, the recommended exposure fell last week to 32.2% (from 46.6% the week before). The maximum historical level the HGNSI has reached is 89.6% so this is very subdued in light of the rally we are seeing.

As well, Market Vane’s Bullish Consensus sentiment indicator for gold fell by 3 percentage points to 74%. Although this is a tad on the high side, it is still not at maximum levels (above 80%). But the most important thing is that we are not seeing a drunken excitement in the gold market - at least from this measure.

The Daily Sentiment Index, from trade-futures.com, however is showing an extremely high level of bullishness for gold. At last Wednesday’s high, the DSI for gold reached 98% - implying that basically everyone agrees that gold is going higher in price. This level is not only extremely high by its own regard, it is also the highest DSI reading for gold in the history of this indicator reaching back to 1987!

The last time we came close to this DSI level was on November 17th 2009 (97%), March 3rd 2008 (97%) and November 7th 2007 (97%). Having said that, Jake Bernstein, the creator of the Daily Sentiment Index indicator is the first to tell you that you don’t just trade of it with your eyes closed.

Bullish Percent
The bullish percent index for the Gold Miners Index is 77.42%. That is relatively high compared to the historical averages but it isn’t yet at an extreme that would correspond to market tops. I’d prefer to see the bullish percent above 85% before I’d feel comfortable shorting gold stocks. See this for a background on how I use bullish percent charts to time the market.

Gold vs. Gold Shares
Last week gold shares were uncharacteristically strong while gold itself was weak. The Gold Bugs Index was up 7.34% for the week while gold squeaked out a 1.4% gain. While the metal has broken up gold shares (as represented by HUI) haven’t. This worries many who see the divergence as a sign of weakness. But it may simply mean that there is less froth in the gold market than we think. Usually due to their higher beta gold shares are the go to vehicle for speculators, especially retail market timers who are unfamiliar with the commodities futures market.

If you’ve been long gold, first, congratulations! Second, here is a short video on where to place intelligent stops. Reading the cross currents of gold sentiment is very challenging right now. Previously we looked at Rydex traders and their subdued reaction. The above sentiment indicators unfortunately don’t help to clarify the situation but provide a hodgepodge. In this light, I’d defer to the clearly parabolic nature of the charts and be cautious rather than bold.