Last week we discussed the potential for a rally in the gold sector (see: “Gold Stocks at an Interesting Juncture” for details). Gold stocks jumped early in the week and then retraced almost precisely 50% of the initial move higher, in the process closing a gap that was left behind on Wednesday.
Interestingly, for the first time in many months, there were three up days in a row prior to the retracement move:
The HUI Index daily: a jump from 104.50 to 126.25, followed by a 50% retracement: ideally the advance should resume from here – click to enlarge.
On a 10 minute chart of the HUI index zooming in on the entire move since the low of August 7, one can see that the retracement includes a saucer-shaped sideways move that was put in during Friday’s trading session right at the 50% mark.
Note that the 50% mark appears slightly higher on a 10-minute log chart than on the daily log chart shown above, mainly due to the different scale of the chart. It is nevertheless fair to say that there has been a 50% retracement of the initial move off the low so far.
Last week’s action reminded us of the 1992/1993 low. At the time, there was a big single day move higher in the Johannesburg Gold Index shortly after the low had been put in, which was almost completely retraced the very next day. The rally resumed shortly thereafter. The XAU behaved differently in 1992/3, but as you will see further below, the chart nevertheless provides interesting information.
First a look at the above mentioned 10 minute chart though, which is informative as well:
A 10 minute log chart of the HUI since the low on August 7. The point of showing this close-up is to illustrate the difference between the advance and the pullback. For once, the former exhibited more urgency, and looks “impulsive”, while the latter has so far a more “corrective” look. Of course this can easily change again, but this is the situation as of Friday’s close – click to enlarge.
Sentiment – Gold Remains the Most Hated Asset
Before we move on the 1992-1993 chart, here is a list by sentimentrader, which shows a comparison of the so-called “optimism indexes” for major commodities. The numbers show the bullish consensus as a percentage.
Here is sentimentrader’s explanation how these indexes are calculated:
“To calculate this gauge of public opinion, we have created an index based on many of the established surveys currently in existence, along with other measures of sentiment, such as from the options and futures markets. The combination of that data is the foundation of the Optimism Index, or Optix.”
As you can see below, commodities are generally not getting much love right now, but gold manages to stand out as the least loved of all. Not even crude oil attracts such a paucity of bullish opinion right now, in spite of having suffered a significantly larger and more relentless price collapse:
There are only 14% bulls left in gold, when combining all major surveys and positioning data. Platinum with 16% bulls is fairly close, and in commodity futures, only cocoa currently exhibits a bullish majority.
Since sentiment and positioning to a large extent simply tend to follow prices, this doesn’t guarantee anything, but the probability of a counter-trend move (in this case a rally) increases the more extreme sentiment and positioning data become. Once everybody has already adopted bearish positions, there is so to speak “no-one left to sell”.
Bottoming Formations Can be Tricky – The 1992-1993 Example
The 1992-1993 situation illustrates an important point. Primarily it shows how extremely tricky a bottoming process in gold and gold stocks can be. Gold stocks initially attempted to decouple from a still declining gold price for several months in 1992, only to fall prey to a final sell-off to a marginal new low. Then they made another decoupling attempt in early 1993 – this time a successful one.
The divergences between gold and gold stocks are indicated by the blue dotted lines below and the late 1992 – early 1993 start of the rally is shown in the blue rectangle. Interestingly, when gold finally bottomed and started moving higher, gold stocks had been rising for a few weeks already (we are using the XAU Index in this case, as the HUI didn’t exist yet in 1992):
Gold stocks attempted to decouple from gold between May and October 1992, only to succumb to a final wave of selling in November. This was followed by another decoupling attempt beginning after the late November low – timid at first, then accelerating. By the time gold itself finally bottomed in March of 1993, gold stocks had been in rally mode for several weeks already – click to enlarge.
The early 1993 rally in gold stocks was a pretty strong bullish signal that was easy to recognize. What made the bottoming process tricky was mainly the sharp sell-off in November 1992 – the index essentially crashed over the first three days of this selling wave, undoubtedly crushing whatever hope the May-October advance had provided – especially in view of the index falling to a marginal new low at the end of November 1992. Essentially one could say that the low was foreshadowed well before it was actually put in.
Also worth noting is that the final crash into the low was very similar to the recent crash-like move in the HUI in July. The main point we want to make though is that the market will often act in a manner that keeps people convinced that the previous trend will continue just before it actually changes direction.
Recent Developments in Junk-Bond Land
As we pointed out last week, US inflation expectations are currently declining rather noticeably (see: US Inflation Expectations Decline Sharply for details). This is usually negative for gold, as it raises real interest rates, unless nominal interest rates decline even faster.
However, the “stealth bear market” in junk bonds, which we also discussed last week, has suddenly become a great deal less stealthy. Especially bonds with the lowest ratings were crushed late last week, with CCC yields jumping by 240 basis points on Thursday alone. Yields of this market segment are now approaching levels last seen in 2011 at the peak of the euro area debt crisis:
Yields on CCC rated bonds: from 13.58% on Wednesday to 16.18% at the close of trading on Thursday. Such huge short-term moves were last seen in 2011 when euro-land was under maximum debt stress.
Credit spreads are among the drivers of the gold price, and this particular driver has now clearly turned bullish for gold – which is probably balancing out the negative influence of declining inflation expectations to some extent. If the panic in the lowest rated junk bonds spreads to higher rated junk bonds as well, this factor would probably begin to outweigh the negative effect from the trend in inflation expectations.
More Nonsense on Gold Demand by the WGC
Speaking of gold price drivers, the WGC has once again published “gold supply-demand” data that simply make no sense. We quote:
“Global demand for gold plummeted 12% to a six-year low in the second quarter, as vital buyers in Asia lost their appetite for the metal, the World Gold Council said Thursday.
Demand for the precious metal weighed in at 914.9 tons between March and June of this year, down from 1,038 tons during the same period in 2014, according to the industry body’s latest Gold Demand Trends report.”
How can there only have been demand for 915 tons of gold in an entire quarter? We would estimate that roughly between 1,200 – 1,500 tons of gold are traded globally every single day. Not only that, but the total supply of gold is approx. 180,000 tons, so obviously there has to be sufficient demand to offset this supply. Unlike crude oil, gold is not consumed – all the gold ever mined remains in existence and most of it is presumably available at the right price.
Readers who have missed Robert Blumen’s excellent article on the concept of gold supply and demand should take a look here: Misunderstanding Gold Demand. Robert expertly takes analyses like the WGC’s apart, using the very similar supply-demand model of the CPM Group as an example.
We wish we knew where exactly gold and gold stocks are relative to previous bear markets in the sector that were similarly long in the tooth. Unfortunately our crystal ball remains clouded in that respect. However, the recent extremes in sentiment and positioning as well as the sharp sell-off that created the lowest RSI reading in the HUI’s history suggest that the recent move up may be more than just another fluke.
The example from 1992/3 shows that a bottoming process can become quite complex and difficult to navigate in real time, but there are always subtle differences, so things will certainly not proceed in exactly the same manner this time around. We only wanted to underscore how hard it can be not be shaken out just as the market gets ready to move.
Lastly, although the seasonally strong period has frequently failed to provide support to the gold price since the 2011 peak, the fact remains that September has tended to be the seasonally strongest month for the metal over the long term. This year it would coincide nicely with a market that seems more than ripe for a rebound anyway.
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