Don't Count The Gold Stocks Out Just Yet

Includes: DUST, IAU
by: Clif Droke

Gold mining stocks are important reflections of gold's overall health.

Bulls and bears are evenly matched, but the longer trend is still bullish.

Expect gold miners to rebound once safe-haven dollar demand subsides.

While the gold price continues its directionless trend in the face of a resurgent dollar, a battle for control of the intermediate-term (3-9 month) trend is raging in the gold mining stock arena. After a 3-month runaway rally, gold stocks have hit the proverbial wall and are trying to stay above a critical (and widely watched) trend line. In today's report, we'll discuss the near-term prospects for the gold mining and exploration shares in light of gold's recent setback. I'll make the case that while a period of lateral consolidation - or sideways trend - is likely needed to repair the overheated condition of the gold stocks, the bulls should ultimately prevail as the precious metal's recovery continues.

Continuing our discussion from last time, last week's move to a 52-week closing high in the U.S. dollar index (DXY) was significant for gold investors. If nothing else, it served as a "shot across the bow" that gold is once again coming under competitive pressure from the greenback. Fundamentally speaking, the dollar's threatened upside breakout from its 4-month sideways trend is of critical importance for gold investors. Gold's currency component is the single most important factor for determining its major directional moves. And while the gold price can sometimes move counter to the dollar's short-term swings, its intermediate- and longer-term trends are largely a result of how strong or weak the U.S. currency is (since gold is priced in dollars).

U.S. Dollar Index

Source: BigCharts

The net result of the dollar's recent strength was a drop in bullion demand, pushing the April gold futures price sharply lower in the last couple of weeks. The gold price is currently consolidating above the $1,280 level and is trying to regain enough strength to rally back above its nearest round-number benchmark at the $1,300 level. Yet the increased demand for dollars on the part of global investors has temporarily shunted gold to the sidelines as the greenback takes center stage as a preferred safe-haven asset. The revival of fears over the economic stability of the eurozone has been among the key factors in the stronger dollar. The ECB's recent announcement of a new round of stimulus as the central bank sharply cut its 2019 growth forecasts served as a catalyst for the dollar rally.

The final verdict on the eurozone's weakness isn't in yet, and this has allowed the gold price to stabilize in the last few trading sessions. It has also kept the dollar index from extending its recent gains. Thus, there is no clear immediate direction for the gold price yet as the market remains in a state of flux. To get a better view of gold's overall health, let's put aside our discussion of the dollar for a moment and instead turn our attention to the shares of the major gold mining and exploration companies. This is an important consideration, for gold mining equities are important in their own right. Indeed, they often serve as a leading indicator for the future direction of the gold price itself. This is why it's useful to periodically examine the major miners for clues as to the yellow metal's future direction.

Gold stocks have had their own series of successes in recent months, thanks in large part to increased bullion demand. Putting the impressive strides made by the major gold mining stocks into perspective is the following graph which shows the PHLX Gold/Silver Index (XAU) over the last year. From a low at just above the 60.00 level last September, the XAU managed to recover some 80% of its losses by late February. It has since pulled back, however, and nearly broke under its widely-watched and psychologically significant 50-day moving average. This important trend line has remained intact, however, and has never been violated on a weekly closing basis. Thus, the XAU's intermediate-term recovery is still technically intact based on the strength of the 50-day MA.

PHLX Gold/Silver Index

Source: BigCharts

However, when we take a closer look at the XAU, we find that while the index remains above its 50-day trend line, it's still under its 15-day moving average as of March 11 (below). After violating the 15-day MA in late February, the XAU index confirmed that its immediate-term (1-4 week) rising trend had been broken. This temporarily gave the sellers control of the near-term gold stock trend, which they've had ever since. A 2-day higher close above the 15-day MA will allow the bulls to regain control of the immediate trend - a control that will be solidified by a weekly close above the 15-day moving average. For now, the bears enjoy an advantage in the immediate term, and this should be respected by gold stock traders.

PHLX Gold/Silver Index

Source: BigCharts

Under the rules of my trading discipline, this means no new long positions in the actively traded mining shares should be initiated until the XAU confirms the next 15-day MA buy signal, as explained above. It's not a time to sell or sell short, however. As long as the XAU remains above its 50-day MA on a weekly closing basis, the more important intermediate-term trend remains in the control of the bulls. The tug-of-war between the bulls and bears can clearly be seen in the above two XAU graphs.

Looking at these graphs, you can see that each time the XAU tried to rally in the last two months, it encountered strong resistance at either the 76.00 level or the 80.00 level. The result was three separate peaks being established since early February. Technicians often refer to this as a "head and shoulders" pattern. Unlike other technically-oriented traders, however, I don't consider this pattern to have any special forecasting significance. Historically, it has alternated between being a reversal pattern or a continuation pattern. In statistical terms, this undermines its credibility for consistently predicting the future direction of prices.

What the above price pattern tells us, though, is that a fairly even balance has been struck between buyers and sellers in the actively traded gold shares which comprise the XAU index. The winner of this tug-of-war is likely to be the side that forces the XAU a few days higher above its 15-day moving average (i.e. above the 76.00 level). This should happen fairly soon in order to prevent a loss of the XAU's near-term price momentum. Assuming we get the 2-day higher close above the 15-day MA in the coming week, there's an excellent chance the bulls can quickly reestablish their control over the market and push the bears completely to the side while forcing the XAU to a new high above the 80.00 level later this month.

Another indicator which will be important to watch in the coming days is the Direxion Daily Gold Miners Bear ETF (DUST), which trades inversely to the XAU index. DUST confirmed an immediate-term buy signal at the end of February when it closed two days higher above its rising 15-day moving average. This confirmed the XAU's reversal of its immediate-term rising trend last month. However, as the rally in DUST hasn't been firmly established yet, it's still possible that the buy signal in DUST will fail (or put another way, the XAU index can still rally). To that end, a close below the nearest pivotal low at the $18.00 level (the closing level immediately prior to last month's upside breakout) would technically break the uptrend in DUST and would pave the way for a rally in the actively traded mining shares.

Direxion Daily Gold Miners Bear ETF

Source: BigCharts

Let's now take a look at the gold-tracking ETF used in this report, namely the iShares Gold Trust (IAU). As can be seen below, IAU is still below its 15-day and 50-day moving averages after closing the latest week below both trend lines. What this means in simple terms is that both the intermediate-term and immediate-term trends must be classified as neutral-to-bearish for the gold ETF. Last month's downside move in IAU reversed its 4-month rising trend and - temporarily at least - gave the gold bears an advantage that still persists. We're now waiting for IAU to close two days higher above its 15-day MA, which will confirm an immediate-term (1-4 week) bottom per the rules of my trading discipline. Right now, though, a combination of a strengthening dollar and a weak euro outlook continues to weigh on gold and gold-tracking funds. Accordingly, I recommend that we remain in a cash position until we have confirmation that strength has returned to the precious metals market.

iShares Gold Trust

Source: BigCharts

To summarize, the gold price remains subject to its weakened currency component as long as the U.S. dollar index remains above its 50-day trend line and near its yearly high. Gold's important fear component, however, remains strong and should keep the yellow metal price buoyant and within its trading range of the last several weeks. Fears over the global economic outlook will almost certainly persist, which in turn will lead to renewed safe-haven purchases of the metal once the dollar rally has ended.

As long as the dollar index doesn't continue to rally on a sustained basis, gold's lateral trend should allow the bulls to consolidate their control over the metal's intermediate trend. Eventually, gold should be strong enough to push out of its recent trading range and continue the recovery it began last fall. The gold mining shares, by extension, will also be able to benefit from the next leg of gold's recovery. For now, though, participants should continue to keep their powder dry while we wait for the gold price to bottom and for the U.S. dollar to weaken. Gold ETF traders, meanwhile, should remain in a cash position.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.