Evidence Of Capitulation In The Gold Market

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Includes: ABX, GOLD, IAU
by: Clif Droke

Summary

Gold bulls are showing signs of finally giving up on gold.

This removes an important obstacle for a near-term gold rally.

Recent mining stock strength is also favorable for gold outlook.

The gold price remains subdued as September heads to a close. The bulls have been unable to rally the metal despite an improved technical and fundamental backdrop. But for the first time in months, an important shift has occurred in the investor sentiment backdrop for the yellow metal. As I’ll argue in today’s report, this shift suggests the bulls should have a short-term technical advantage entering October. A recent increase in activity on the mining company front should also help boost gold’s near-term prospects.

Gold prices were higher on Tuesday as the dollar weakened. Investors have held off on making big commitments to the metal ahead of Wednesday’s Federal Reserve monetary policy decision. Although the yellow metal price is trying to rally, it continues to face headwinds from strong U.S. economic news and the threat of higher interest rates. Spot gold was just 0.2% higher on Tuesday, closing at the psychologically significant $1,200 level. December gold futures rose 0.1% to close at $1,205. Yet, despite the latest attempt at rallying, gold hasn’t yet gained enough traction to force the bears into short-covering mode.

One of the biggest detriments to a gold recovery rally has been the stubborn refusal of the bulls to let go of their bullish sentiment toward the yellow metal. Indeed, there were a few times since April when fund managers and retail investors alike increased their long exposure to gold after it declined in anticipation of a major rebound. Each of these expectations was disappointed, however, and the bulls were left disappointed as the dominance of the U.S. dollar continued to push gold prices lower.

Recently, though, there has been a shift in participants’ expectations for gold and the dollar index. Investors and analysts alike have become increasingly aware of gold’s inverse relationship with the U.S. dollar. Earlier this year, it wasn’t uncommon to hear the gold bulls dismiss the threat of a rising dollar on the metal’s price. But after several months of dollar-induced weakness, even the naysayers have come around. In recent weeks, many analysts have pointed out that gold and the dollar have a negative correlation of approximately 85%. That this statistic is now being widely quoted as proof of investors’ acceptance of gold’s weak currency component. This in itself could be interpreted as a sign that the last of the gold bulls have capitulated and have sold out. This is a necessary precursor to the short-term recovery rally I anticipate will happen in October.

On the mining stock front, Canadian blue chip miner Barrick Gold (ABX) announced this week it has agreed to purchase Randgold Resources Ltd. (GOLD) for $6.5 billion. The merger will create the world’s largest gold producer. According to Reuters, the new Barrick will own five of the 10 lowest-cost gold mines in the world, with a market value of over $19 billion. The announcement of this deal resulted in a notable rally for Barrick shares, as can be seen in the following graph.

Barrick Gold

Source: BigCharts

The timing of the Barrick announcement couldn’t be better from a technical standpoint, as we’ve discussed in recent reports. Earlier this month, the internal momentum profile for the 50 most actively traded North American gold stocks, which includes Barrick, began showing notable improvement. After being in decline for most of this summer, the 4-week rate of change of the new highs-new lows for the actively traded mining stocks commenced a sharp rally. This can be seen in the following graph.

Gold Stock 4-Week Momentum

Source: WSJ

The above graph tells us that the incremental demand for gold stocks has increased on an immediate-term (1-4 week) basis. This is the reason for the recent rally in many of the major gold mining shares, and as long as this indicator continues its ascent, the path of least resistance for gold stocks will remain up.

This substantial improvement in the internal condition of gold mining stocks is one reason why investors should expect to see some improvement in the gold price in October. Following a major decline, relative strength and leadership in gold mining stocks typically precedes improvement in the near-term outlook for the bullion price.

Another factor which bodes well for gold entering the fourth quarter is the dollar/gold ratio. I’ve made continual reference to this important indicator throughout the last few months, and until recently, it has favored holding cash over gold. The dollar/gold’s bearish signal for gold is showing signs of reversing, however. As can be seen here, the ratio has fallen below its technically significant 30-day moving average for the first time since April when gold’s troubles began. As long as the dollar/gold ratio remains under this short-term trend line, the bulls will have a fighting chance at regaining control of the gold market and forcing a short-covering rally.

U.S. Dollar/Gold Ratio

Source: StockCharts

All that’s needed for gold to confirm an immediate-term bottom is a 2-day higher close above the 15-day moving average, which is the basis of my technical trading discipline for gold. This hasn’t happened yet, but the gold bulls still have a fighting chance this week based on the dollar’s recent weakness. The iShares Gold Trust ETF (IAU), my gold trading vehicle of choice, has spent the last few trading sessions hugging the 15-day MA but hasn’t been able to rally decisively above it. I must also re-emphasize the importance of the $11.60 level for IAU, which is the pivotal high established Aug. 25. This serves as IAU’s highest closing price in the last five weeks since its bottoming attempt first began. A close above $11.60 would technically confirm a bottom for IAU based on my trading discipline. It would also likely serve as a catalyst for additional covering of the huge short interest which has built up in the gold market in recent months.

iShares Gold Trust

Source: BigCharts

In conclusion, the odds for a gold short-covering rally in the coming weeks are as high now as they’ve been in months. Whether or not the rally actually commences, though, is entirely up to the bulls. My best guess is that the recent strength in the leading gold stocks like Barrick will stimulate some interest in physical gold among value investors. Continued weakness in the U.S. dollar index will also increase the chances for a gold rally in October.

Strategically, no action need be taken among gold investors just yet, but we are close to another immediate-term buy signal. All that is required for a renewed entry signal is for the iShares Gold Trust ETF to close above the $11.60 level. This in turn would complete an immediate-term bottom signal per the rules of my trading discipline. 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.