Turning Bullish on Gold and Gold Stocks

After flagellating myself for too much bearishness, the last time I wrote about the yellow metal I mentioned that I would be returning to it when it presented with a buying opportunity:

The best combination of breadth is strong long term (200 day average) and weak short term (10 and 50 day moving average). A good example was in mid-December 2007 when there were only 10% trading above their 50 day MA and 5% above their 10 day MA with a very high 60% above their 200 day MA.

I’m keeping a wary eye on this sector until it presents a similar setup and will post about it.

After its top in March, the Philadelphia Gold Bugs Index (HUI) fell almost 20% in the span of a few weeks. And since I was distracted, I missed the opportunity to write about arriving at the exact oversold condition that I described above.

But since things haven’t significantly changed in this sector, let’s have a look. The commodity itself fell from a high of almost $1034 to $876 and it pulled down gold equities with it:

click to enlarge

Gold Sector Breadth
We now have almost 60% of gold stocks trading above their 200 day moving average. So as described above, the long term is still in good shape.

And the short term is weak: in early April, only 10% were trading above their 10 day moving average. Similarly, only 20% were trading above their 50 day moving average.

Since then of course, they have moved up slightly but neither is so far extended to remove the oversold opportunity.

Gold Bullish Percent
The recent decline in the Philli Gold Bugs Index (HUI) also caused the bullish percent index [BPI] for the sector to kiss the 30% line in early April 2008.

Historically, when the bullish percent falls to this level or lower it is a good time to “rent” some gold stocks. The previous instance was in January 2008.

Since there is nothing magical about this 30% area, the BPI can crash through it to reach significantly lower levels. For example, in October 2007, the gold BPI fell to almost 15%.

Getting back to today’s conditions, since earlier this month the BPI has recovered along with gold and gold equities. But we are still at a low enough stage that catching and riding a rally are possible.

Gold Sentiment
According to Mark Hulbert, the newsletters that write about gold and time in this sector are now quite bearish. The Hulbert Gold Newsletter Sentiment Index [HGNSI] is now at -17.2% - meaning that these newsletters are now actually recommending their clients short the market.

While the all time record for pessimism comes in at -31.3%, this measure of gold sentiment has been lower than the current reading only 2% of the time in the past 20 years.

Since gold is clearly in a secular bull market, such a quick retreat after a ~20% drop shows that there is a complete lack of stubbornness on the part of the gold bulls. From a contrarian measure this is very promising for the continuation of the gold bull market.

So when you have breadth, bullish percent (an alternative measure of breadth) and sentiment all congruently pointing one way, you have a pretty good chance for a profitable trade.

Comments

[NI123]

Nice article. I sold all of my gold and silver holdings at around $980, and just recently bought some GLD at $904, which has a 10% stop loss backing it. Gold could very well drop back to $830 or even $770, and I am 50/50 on which way it will go from here. If the financial turmoil starts back up and the dollar keeps dropping, it will almost certainly begin appreciating again, at least in the short term.

[maher]

Babak Jaan -- Thank you for your somewhat convoluted argument about the prospects of gold. I am easily confused, of course, but I agree with you on the overall direction of the market. Ghorboonet Beram - Maher

[mark mchugh]

Am I the only one who's concerned about the risks of e-gold? I've been looking at the possibility of physically holding gold and it's proving more challenging than I thought.

Can anyone reassure me that holding GLD is just as good as having the metal and that they would never price shares that they didn't have? Or, can someone give me direction on how to safely navigate a physical purchase?

[tireman]

You are correct to be worried about default of delivery upon demand. Even though ETF's don't pay off in physical silver to you when you want to sell, some warehouse is supposed to report that silver to a new owner. In an oversold (fraudulent) condition somebody gets caught holding an empty bag. That is why I buy a variety of silver bullion products. My favorite are silver rounds and American Silver Eagles.

[your_avid_investor]

Babak, thanks for the article. If I understand you correctly, you basically present a bearish case for Gold and then adopt a contrarian view to the analysis. That is one heck of a confusing way for being bullish on gold. Neverthless, thanks for the data.

[mark mchugh]

Tireman,

Where do you buy them?

[fg144331]

Most any coin store will sell rounds or other var of gold and silver. You might want to check prices on the net too. Go to Google and "silver".

[mongoose]

I have very good experience with ( golddealer.com)They have always performed as expected.

[mongoose]

That is California numismatics