Gold And Gold Stocks - Another Retreat Post FOMC

Includes: ABX, GLD, NEM
by: Acting Man

Rejected by Resistance Again

It was already foreshadowed by the short term overbought condition in gold stocks that gold would likely turn down again and remain in technical no-man's land. There was a break-out attempt just prior to the FOMC announcement, and experience shows that strength ahead of the FOMC meeting is usually followed by weakness thereafter and vice versa. Note here that the content of the announcement is largely irrelevant (the October announcement didn't differ from the September announcement). Moreover, anyone who hasn't been in a coma over the past 5 years should by now have realized that there will be no "exit" from money printing anyway, regardless of what is or isn't said.

What matters for gold at the moment is apparently mainly the market's technical condition, with prices oscillating between resistance and support levels. The longer this continues, the bigger the move following the eventual breakout is likely to be.

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December gold contract, daily, with lateral support and resistance levels.

If the support zone indicated on this messy chart fails, a test of the June low will occur next and conversely, if the resistance zone is surmounted, the August highs are likely to be tested.

On the 30 minute chart we can see how the market turned on a dime after the FOMC announcement, selling off on fairly heavy volume:

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December gold 30 minute chart: downtrend begins right after FOMC non-decision.

The market often uses FOMC announcements and jobs reports as turning point windows, but once again it must be stressed that the content of these announcements and/or reports does not matter much. For instance, the rally in July began after a rather strong payrolls report. That said, several other economic data releases weighed on gold last week. There was another quite strong ISM report, and it was reported that price indexes are beginning to decline in the euro area periphery. This in turn provided an excuse to sell the already overbought euro, on the grounds that it may induce the ECB to cut its minuscule administered repo rate further (currently at 0.5%). Of course we don't know anyone who's buying the euro for its interest rate differential, mainly because it makes no sense (the currency risk cannot possibly be outweighed by a 25 basis point interest rate differential).

Since falling prices are an effect of an ongoing decline in outstanding bank credit in the euro area, it could be argued that these developments are longer term bullish for the euro, regardless of what the ECB does (at least as long as the markets remain convinced the euro won't break up). This is for the same reason for which the yen has been strong for so long – euro area money supply will grow more slowly, and may eventually even shrink. It seems unlikely that the ECB will be able to counter these developments, given its modus operandi. It needs the cooperation of the private banks, but many of Europe's banks are in trouble and in no mood or position to expand their lending, especially in view of tougher capital and leverage rules coming down the pike. Given the ongoing expansion of the State in much of Europe, the private sector is in any case unable to bear a higher debt load.

Lastly, the SPDR gold trust GLD continues to slowly bleed gold. From a high of more than 1,300 tons once held by the trust, only 866 tons remain as of Friday last week. While the amounts involved are largely irrelevant relative to the size of the gold market, GLD holdings are a useful sentiment indicator, and they show that sentiment among Western gold investors continues to be negative.

Gold Stocks – Pressured by ABX?

In our last update we warned that heavy call buying in Newmont Mining (NYSE:NEM) ahead of its earnings was unlikely to be a good sign. We wrote:

“We generally don't like to see a lot of speculation in calls ahead of an earnings report. In fact, we are always keeping an eye out for unusual options activity in the sector, and our experience over the past two years has been that heavy call buying almost never works out for the buyers.”

So far the record of call buyers in the sector remains unblemished by success as the daily chart of NEM shows. In spite of the fact that the company delivered an "earnings beat" due to better than expected cost controls, the stock promptly tanked. Not only were earnings higher than a year ago, but the result was a lot better than the consensus estimate (46 cents after one time items vs. a 32 cents consensus) – however, the call buyers lost anyway:

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NEM dives after solidly beating estimates.

It may well be that the weakness in NEM and the sector as a whole was triggered by an announcement by Barrick Gold (NYSE:ABX). The management of ABX thought it was a good time to dilute its shareholders and announced the sale of 163 million shares at $18.35 in order to pay down debt. At the same time it announced that it would suspend construction at its Pascua-Lama development project, which has been plagued by cost overruns and regulatory troubles.

ABX concurrently delivered an "earnings beat" as well, but that was considered less important than the message the company sent with its capital raising and the suspension of construction at what was hitherto deemed a "flagship" project. It certainly indicates that Barrick's management is getting worried about "what if" scenarios, such as "what if the gold price keeps falling".

With its more than $15 billion in debt, the company may conceivably run into difficulties if that happens. It should be stressed though that managers of gold mining companies have no special insight into the future of the gold price (in fact, their forecasting record is rather patchy). Nevertheless, in a market in which sentiment is already fragile, such announcements are greeted by 'sell first, ask questions later". And so ABX lost a hefty 12% in two trading days on the heaviest volume in quite some time:

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ABX tanks after diluting its shareholders.

As a result of all this commotion, the HUI fell rather swiftly (with gaps) from its recent visit of the upper Bollinger band. If it is its usual self, it will now decline to the vicinity of the lower band, so one needs to watch whether or not that actually happens. If it does, it will simply be business as usual. However, if it doesn't, it should be considered a sign of strength.

The decline in the HUI-gold ratio has resumed as well. In this ratio we have now seen both a failed breakout and a failed breakdown in a relatively short time span. What is a slight negative is that both prices and the ratio are declining from lower highs. The reason why we say that this is only a 'slight" negative is that all in all, the index remains in technical no-man's land (similar to the metal). However, if it is to turn up, it must do so soon. Gold stocks have a strong tendency to produce major highs and lows in either the May-June or the October-November period. When an existing trend doesn't turn in one of these time frames, it usually continues into the next 'turn window".

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The HUI with Bollinger bands (20,2). There have now been two lower highs in a row following on the heels of FOMC announcements. Note that in between the "pincer highs" of August, the Fed minutes of the July meeting were released.

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HUI-gold ratio: a series of lower highs, but also a failed breakdown after the previous failed breakout. That leaves the sector in no-man's land so far.

Although the charts suggest that there could be more short term weakness, the previously discussed positive divergence between the index level and the GDM bullish percent index (which shows the percentage of gold stocks on a point & figure buy signal) hasn't been negated yet:

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GDM bullish percent index vs. the HUI (green line below).


Prior to the FOMC announcement it briefly looked like gold may be about to break above resistance, but it was not to be. As a result, there is still no conclusive signal as to the direction of next major intermediate term move.

If the sector is bottoming, it is certainly taking its time. As usual, earnings season hasn't been kind to gold stocks so far, in spite of a number of earnings beats. On the other hand, if the metal isn't embarking on another major downleg, gold stocks remain in bargain basement territory. Historically such large declines in the sector relative to the gold price have been followed by strong rallies, but we will need to wait and see whether the support levels established in recent months will continue to hold.

Charts by: BarCharts, StockCharts