Another Gold Inflection Point Is Here

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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 bulls finally have a chance at igniting a short-covering rally.

Dollar shows signs of vulnerability, which will help the case for gold.

Gold stock bulls also have a short-term technical advantage.

The wait for a meaningful rally in the gold price may soon be over. In this commentary we’ll discuss the latest technical improvements in the precious metals arena, including the sudden liveliness displayed by the leading gold mining stocks. I’ll argue that the fuse for a worthwhile short-covering rally was lit this earlier week and will ignite a rally if gold’s currency component shows any additional weakness in the next couple of days.

Gold’s fortunes have improved drastically in the last three trading sessions. After threatening to probe its August low, the gold price rallied sharply on Wednesday and is back above its technically significant 15-day moving average as of Sept. 13. Although the December gold futures price pulled back 0.37% on Thursday, it stopped short of violating the 15-day MA as can be seen here. The most important takeaway from gold’s performance in the last three days is that the bulls are finally showing some spunk and are clearly trying to gain control of its immediate-term (1-4 week) trend.

December Gold

Source: BigCharts

According to the rules of the trading discipline I employ in this report, an immediate-term bottom is established when the gold price closes two days higher above its 15-day moving average without reversing this signal on the all-important follow-through day. Amazingly, the gold price has been unable to accomplish this simple act since April.

Gold’s failure to confirm an immediate-term bottom in the last five months is a testament to the stubborn strength of the U.S. dollar index (DXY) during this time. It has been my contention that a sustainable rally in the gold price isn’t possible without significant deterioration in the value of the dollar index. To that end, we’ve been focusing on the relationship of the DXY price line with the 50-day moving average in recent reports. The 50-day MA is a meaningful trend line by virtue of its being so widely watched by traders, both on the institutional and retail levels.

Since many participants consider a violation (up or down) of the 50-day MA to be a reliable trend reversal indication, significant violations of this moving average can be self-fulfilling. As can be seen in the following chart, the dollar index has decisively penetrated below its 50-day MA as of Thursday’s close. A weekly close below this moving average on Friday will seal the deal, technically speaking, in terms of violating this psychologically significant trend line.

U.S. Dollar Index

Source: BigCharts

If the dollar index closes the latest week below its 50-day MA, what can be expected to follow? Assuming this happens, my best guess is that next week would witness the beginnings of a short-covering gold rally as the gold shorts are forced to cover under the threat of a weaker dollar. The gold short trade of recent months has been predicated on a stronger dollar, thanks in large part to the demand for dollars from emerging markets investors in search of a financial safe haven. If the gold shorts see the dollar so much as the threat of a breakdown in the dollar index, a quick move into gold would logically follow.

To that end, the 50-day moving average will become equally important for the gold price. For instance, the following graph shows my favorite gold ETF, the iShares Gold Trust (IAU). As you can see here, IAU tested but failed to close above its 50-day moving average in the last two sessions. However, a successful close above the 50-day MA from here would force the gold bears to sit up and take notice. IAU hasn’t been able to close above its 50-day MA since its bear market began in April. A close above the 50-day MA, especially if it occurs on weekly closing basis on Friday, would be impossible for the bears to ignore as it would be an undoubted show of strength on the part of the gold bulls. With the gold price already deeply “oversold” thanks to an enormous buildup of short interest, gold bears would be faced with an overpowering incentive to cover their short positions.

iShares Gold Trust

Source: BigCharts

Meanwhile on the mining stock front, the PHLX Gold/Silver Index (XAU) rallied over 3 percent on Wednesday in what was likely a short-covering move. This was the XAU’s biggest show strength on a 1-day basis since April, thus it shouldn’t be blithely dismissed as simply a 1-day wonder. A follow-through rally which pushes the XAU above its 15-day moving average would be the first step in the right direction as far as confirming an immediate-term (1-4 week) bottom for the gold mining stocks.

PHLX Gold/Silver Index

Source: BigCharts

Helping to pave the way for the latest XAU rally was the rate of change reversal in the new highs-new lows for the actively traded mining stocks. The new highs and lows are an excellent reflection of the incremental demand for gold stocks, and when the 4-week rate of change (momentum) in the cumulative new highs-new lows reverses a downward trend it signals to technically-oriented traders that the path of least resistance for gold stock prices has turned up on an immediate-term basis. As long as this indicator is rising, it means the gold stock bulls at least a temporary advantage over the sellers since it reflects an increased vulnerability to short covering in the market for gold mining stocks.

Source: WSJ

While 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 and closing under its 50-day moving average on a weekly basis. 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.