Gold: Extremely Rare Signal Points To Higher Prices

| About: SPDR Gold (GLD)

Summary

Gold started the month off with a 5% decline, sending the metal plunging from $1,320 / oz to $1,250 / oz in 5 days.

Despite the U.S. Dollar rallying 2% in a week to new 6 month highs, gold did not make a new low during this period.

The price of gold remains in an uptrend on the daily and weekly charts.

Despite a volatile start to the month, the past week in gold (NYSEARCA:GLD) has felt like watching paint dry. Over the past 8 trading days, gold has traded in less than a 2% range between $1,242 / oz and $1,264 / oz. I will commend the bears that caught the move from $1,300 / oz down to $1,250 / oz, but I believe those still sitting short are severely overstaying their welcome. Most of the bears have cited the U.S dollar as the reason that gold broke down, but if that is their thesis - they should be worried. Gold closed at $1,254 / oz on October 6th and the U.S. Dollar Index closed at $96.70. Over the next 6 trading days the U.S. Dollar Index made a run to $98.13, a move of 1.5% to the upside. This should have spelled doom for gold if your thesis was that a strong dollar correlated with weakness in gold. Instead gold closed at $1,258.95, 0.5% higher than where it was trading before the U.S. dollar rally. As you can see in the below chart, from October 6th on the U.S. dollar made a nice move to the upside. On the left chart, we can see the price of gold which was basically unfazed by this breakout.

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Source: TC2000.com

For those that have been following me this year, I have been very bullish on the metals. I began by highlighting McEwen Mining (NYSE:FSM) and Fortuna Silver in February as a way to play the new gold bull market. Since then both picks are up well over 100%, even despite the recent correction in metals prices. Just last week I wrote about the Gold Miners ETF (NYSEARCA:GDX), as well as 4 other juniors I felt were worth a look at depressing prices. I stated that I believed the worst of the correction was over and it was time to start looking to the long side on the most lean junior producers. I highlighted Torex Gold (OTCPK:TORXF), Roxgold (OTC:ROGFF), Guyana Goldfields (OTCPK:GUYFF) and Teranga Gold (OTC:TGCDF). In addition, my article on GDX unveiled my positions I took at $22.69, within 1% of the lows.

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Source: TC2000.com

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Source: TC2000.com

After aggressively adding to my gold miner exposure for the majority of this year, I had no interest in chasing the junior miners higher after July. This correction was finally the opportunity I was looking for to double my metals positions, and add some new junior exposure. Not only did sentiment on gold was out to a 4% bullish sentiment on October 10th, we also finally saw a test of the rising 200-day moving average. The 200-day moving average is my line in the sand for bull and bear markets, and it acted as a back-stop for a vicious stop run in gold prices. As we can see in this chart, the 200-day moving average had not been tested all year, and a shake-out at these levels was inevitable. After breaking above its 200-day moving average in February, gold saw a 21% rally. The positive news for this rally was that it turned the 200-day moving average from flat to positive sloping. When gold finally came down to test this level last week, I expected the level to provide strong support. Despite nearly a week of barely clinging onto its 200-day moving average, gold is now back above it as of this morning's open.

Gold Makes 3 Month Low With 8-Day Range Less Than 0.75%

Over the past week as stated above in the article, gold has been in an extremely tight range. Tight ranges for markets after making new lows are very rarely bullish going forward. Typically a pattern like this is known as a bear flag, and is a sign a market is consolidating before its next leg down. Surprisingly, bear flag setups are actually bullish for gold prices. Over the past 43 years gold has seen 12 of these occurrences when accompanied with new 3-month lows. One of these occurrences preluded the massive 1977 bull market, while the others showed very positive returns.

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Source: SentimenTrader

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Source: TC2000.com

The above image shows all of these instances, as well as the most recent one in late 2004. In addition I have shown a more zoomed in view of the 2004 signal, which led to higher prices in the short and long term. Six month forward returns for the 2004 signal were 21.48%, and 2 year forward returns were 73.49%. While I am not expecting a 70% rally on this signal, it's interesting to see how the last signal played out for gold investors.

SentimenTrader has noted that for 1-month forward returns, 11 out of 12 of the signals was bullish over the past 43 years. This means that buying this same pattern over the past 43 years, has led to you being right over 91% of the time. I have no reason to believe we won't see a repeat of the past 12 signals, and believe this 13th historical signal should play out very similarly.

Technical Outlook & Summary

Taking a look at gold at the monthly gold chart, we can see a positive development that has occurred during this correction. Earlier this year we saw a breakout from the downtrend line that capped the price of gold since its 2011 top. This correction has not placed us back below the downtrend line, and instead we have back-tested this line and found support there thus far. This is exactly what you want to see as a long as typically downtrend lines are re-tested 6-12 months into a new bull market. The fact that gold nearly perfected tested that line and found support there, is a very positive sign.

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Source: TC2000.com

Moving down to the weekly chart, the October correction in gold prices can be seen very clearly. Last week we saw an inside week on the gold price, which is when price is within the prior week's highs and lows. Inside weeks often mark indecision between bulls and bears, and tend to result in strong moves once price moves outside of the inside week. Minor buy signals are given when price forms an inside week, and then breaks out to the upside above the inside week. Currently this is what we are seeing in gold, as the price was stuck inside the previous week's range, and has now made an outside week above it. To confirm this signal, we want to see GLD close the week above 120.42.

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Source: TC2000.com

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Source: TC2000.com

Interestingly enough, the first large pullback in the 2009 gold bull market also showed a very similar setup. In late 2009 to early 2010, gold saw a 10-week correction that shaved 13% off of the metal. This is quite similar in size to the 12-week 10% correction we have just recently seen in gold. Gold bottomed in early 2010 after making an inside week, and then closing above it the following week. Similar to the 2010 bottom, we closed at an inside week last week and have just moved above it. This signal is contingent however on GLD closing the week above 120.42.

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Source: TC2000.com

Zooming into the daily chart, we can take a closer look at support levels. I have shown my buys and sells in the below chart, from where I initially went long gold, to my recent additions to the position. I initially purchased gold in this article in May. I was already heavily long junior miners at this time, but decided to purchase an initial gold position. Recently I noted 2 buy points that got me interested in the metal to average up. The first buy zone was at $1,295 - $1,300 / oz, and the second at $1,260 / oz. I was only interested in adding 1/3 to my position at $1,300 / oz, but was willing to double my position if we saw $1,260 / oz. Given the violent correction gold saw, I was very quickly filled on both of my long positions. My current average cost on gold stands at $1,253 / oz. My stop on this trade is a close below $1,230 / oz. This does not mean that I believe gold is heading into a bear market, this is just my risk level for the trade. I still hold 40% of my assets in junior mining stocks and would continue to ride them if we lost $1,230 / oz (as long as they held their stops). I have no problem buying gold back if I get stopped out of my trade, but I believe we could see further weakness if the $1,230 / oz level is breached on a closing basis. Do I believe we see sub $1,230 / oz? No. I'm quite confident that the recent shakeout has run its course and while we could re-test $1,245 / oz and make a higher low above $1,240 / oz, sub $1,230 / oz would surprise me.

Taking a look at a less messy chart, we can see that GLD has filled its June gaps, and is sitting above the 200-day moving average. I expect gold to close the day above its 200-day moving average, and I believe the worst is over for this correction. Looking out 12 months, I expect the range in gold to remain between $1,200 / oz and $1,520 / oz. Given that my upper range is at $1,520 / oz, I believe mining positions and gold exposure at current prices to be an excellent move. I believe those that are short gold have severely overstayed their welcome, and will begin to regret it very soon. The $1,250 / oz level has been a brick wall for shorts trying to penetrate it, and I believe this shows us that it's not going to be given up easily. For those who have been waiting all year to add to their gold exposure, this is likely the best opportunity of the year. I remain long gold from my average cost of $1,253 / oz, long GDX from $22.69, and long the majority of my junior miners.

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Source: TC2000.com

I have shown my equity positions below to prove that my money is where my mouth is. I have been holding significant unrealized gains in my investment portfolios but this recent correction did not shake me out of my positions. I see no use in taking profit as long as the long term trend remains up, and therefore I sat with my stocks through the decline. I added to my Torex Gold position, and held all the rest with the same stops on my trades.

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Source: CIBC Investors Edge Account

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Source: TD WebBroker Account

Disclosure: I am/we are long GLD, GDX.

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.

Additional disclosure: If you liked this article and found it useful, please feel free to follow me by clicking on my name next to my avatar at the top of this article. I also invite you to check my performance at TipRanks.com where I am ranked in the Top 100 Contributors for performance with an average return this year of 60% on new long positions.