Focus On The Gold Mining Stocks

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Includes: AAAU, BAR, DGL, DGLD, DGP, DGZ, DZZ, GEUR, GHE, GHS, GLD, GLDI, GLDM, GLDW, GLL, GTU, GYEN, IAU, IAUF, OUNZ, PHYS, QGLDX, SGOL, UBG, UGL, UGLD
by: Clif Droke

Summary

Gold price likely will remain choppy as dollar, interest rates rise.

Gold stocks are in slightly better shape, however.

Short-term downward momentum for gold stocks is reversing.

The month of September has so far been a tough one for gold. The yellow metal just can’t seem to catch a break as the latest headlines -- whether positive and negative -- have failed to stimulate gold demand. Gold’s safety component has been nullified since April as investors have preferred holding cash over bullion while emerging market assets continue to be liquidated. Today we’ll look at the latest factors which point to a continued choppy, directionless market condition for gold in the immediate term. We'll also discuss the immediate outlook for gold mining stocks, which is showing a preliminary (but important) sign of improvement.

The gold price continued to languish on Monday despite hopes for a Brexit deal. Gold investors are still smarting over the latest U.S. jobs report, which showed 201,000 jobs were created in August while the annual pay rate showed the biggest increase in over nine years. Consequently, the December gold futures price is only slightly above the August low and has declined in eight of the last nine weeks.

The latest worry overhanging the market is that the U.S. labor market strength is seen by investors as increasing the likelihood of more Fed funds interest rate hikes. This in turn is a disincentive to own gold due to the competition provided by higher rates. Higher rates also tend to coincide with a rising dollar index, as the dollar and Treasury yields both tend to rise in tandem when the economy is strengthening.

Serving to underscore the currency strength which has undermined gold’s attempts at rallying this summer is the following graph. The U.S. dollar index (DXY) has spent the last few days fluctuating around its 50-day moving average but has confirmed that its intermediate-term (3-9 month) trend is up. DXY closed above its 50-day MA in the latest week, which technically confirms the dollar bulls are still in control of the short-term (1-3 month) trend.

U.S. Dollar Index Source: BigCharts

Of even greater significance than the DXY itself is the following graph which shows the dollar/gold ratio. This indicator serves to measure the relative strength of the U.S. dollar index compared with the gold price. As I’ve emphasized in recent reports, as long as the dollar/gold ratio is trending higher above its 30-day moving average, investors should continue to favor holding cash over gold.

U.S. Dollar/Gold Ratio

Source: StockCharts

Meanwhile the iShares Gold Trust (IAU) remains in a declining trend and hasn’t yet managed a 2-day higher close above its 15-day moving average. This is the minimum technical requirement for a confirmed immediate-term (1-4 week) bottom according to the rules of my trading discipline. While IAU did briefly attempt to reverse its immediate-term downward trend two weeks ago, the signal was quickly reversed before a bottom signal could be established. Traders should remain defensive heading into the latest week and wait for the next bottom signal, which will occur once IAU closes above its nearest pivotal high at the $11.60 level.

iShares Gold Trust Source: BigCharts

On the mining stock front, the PHLX Gold/Silver Index (XAU) hit its lowest level of the year on Monday. Despite the abysmal appearance of its daily chart (below), however, there are is at least one reason for being somewhat optimistic on the prospects for the XAU to finally establish bottom this month.

PHLX Gold/Silver Index Source: BigCharts

Consider that while the number of actively traded mining stocks making new lows has been increasing in recent weeks, the rate of change (momentum) in the new highs-new lows have actually improved. Shown below is the 4-week rate of change indicator for the new highs-lows of the 50 most actively traded U.S. and Canadian gold stocks. This indicator reflects the near-term demand for gold mining stocks in the aggregate. Whenever there has been a conspicuously positive divergence between the 4-week highs-lows indicator (below) and the XAU index (above), it has often served as a precursor to a short-term reversal for the XAU.

Source: WSJ

While the recent reversal in the highs-lows indicator for the gold stocks is no guarantee that the mining stocks will rally in the coming weeks, it’s nonetheless a “heads-up” signal that traders should start watching for signs of relative strength among individual mining shares. If the 4-week new highs-lows indicator continues rising this week, we should very soon have a confirmed immediate-term bottom in the XAU.

In view of this increasing possibility, I recommend that traders be on the lookout for actively traded mining stocks which are making higher lows right now and are showing relative price strength when compared with the XAU index. In the coming days I’ll be watching for gold stocks which fit this description and will share them in this report. Right now, however, the vast majority of the 50 most actively traded mining shares haven't confirmed a bottom and are still below the 15-day moving average.

Although a gold short-covering rally could easily ignite at any time in the coming days, I still recommend a defensive posture for now. Before gold can rally on a sustained basis, the U.S. dollar index (DXY) should show additional deterioration by reversing its latest rally and closing under its 50-day moving average. To reiterate my previous statement, the iShares Gold Trust (IAU) also must close above the $11.60 level to complete an immediate-term bottom signal per the rules of my trading discipline before it can be safely purchased. For now I recommend that investors remain in cash.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in IAU over the next 72 hours.

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.