Is Gold Overextended?

We’ve seen an exceptional start to the year for gold (GLD) with the metal up over 35% year-to-date, surpassing most asset classes for year-to-date performance briefly being thrown out with the March bathwater.

This incredible run has seen the metal put in a new all-time high to finish the month of July, a very bullish development from a long-term standpoint.

However, while the stars are aligned for an eventual move towards $2,350/oz for gold as an initial target, we are beginning to see a couple of caution signs along the way, with bullish sentiment now at its highest readings it’s seen in only five instances in the past twenty years.

Meanwhile, the daily chart is now beginning to get quite extended as well, printing the first caution bars in over six years for the metal. While this doesn’t mean that one should rush out and sell their gold bars, it does suggest that not an ideal time to be buying. Let’s take a closer look below:

(Source: TC2000.com)

As we can see in the chart above, gold broke out of a multi-year base last month and the follow-through from this breakout has been quite impressive.

Since the push above the previous high at $1,920/oz, the metal has climbed another 7% and has sliced through the psychological $2,000/oz level like butter. This bodes well for the gold market going forward, as the first technical target off of this breakout is $2,350/oz.

It’s also a great sign as past resistance levels often become new support levels, and the previous resistance at $1,790/oz could now end up being the new floor for the market. Unfortunately, as noted above, things are beginning to get crowded, and any asset class rarely goes up in a straight line.

(Source: Daily Sentiment Index, Author’s Chart)

As we can see from the chart above, bullish sentiment for gold has headed into the danger zone above 80% bulls and this has typically been a problem for the metal. Following all of these instances, the metal was down by 7% or more in the following three months from its highs, with most instances seeing corrections of 10% or more.

It’s important to note that these pushes into this danger zone are leading indicators, and the metal often continues higher over the short-term. However, any upside that is captured while gold is inside these danger zones is typically retraced, and we’ve been in this danger zone since $1,970/oz.

Therefore, a pullback of 7% from the initial entry into this zone would target a correction down to $1,830/oz at a bare minimum before October. This time could be different, but this time rarely ends up being different in the market as markets are driven by emotions, and human nature never changes.

(Source: TC2000.com)

Meanwhile, from a technical standpoint, the daily chart of gold is now corroborating this view. As we can see above, the 280-day moving average for gold (green line) is quite a bit below price near $1,600/oz and gold has a tough time when it’s 20% or more above this moving average. Meanwhile, the price action for gold with abnormal volatility is signaling caution bars as well (red bars), and this often tells us that we’re seeing panic buying.

Generally, smart money does not panic buy, they buy in panic, and this tells us that retail is finally entering the trade here. While retail can make money temporarily, they often overstay their welcome and corrections ensue. Therefore, I believe that there’s a good chance we might see a correction over the coming weeks, and I certainly would not be chasing the metal here.

So, what’s the best course of action?

While I am in no rush to sell my position in gold that was bought below $1,450/oz, I am certainly not adding to my position here, and might look to lighten up if we head above $2,120/oz before fall.

This is because the trade is now beginning to get crowded, the metal is getting short-term overbought, and the miners are the most popular sector in the market, a bad sign short-term.

While the multi-year breakout points to higher prices over the long run, I am less inclined to believe we’ll see the $2,350/oz target reached in a straight line, so I am being cautious here.

Based on this, I am holding a large position in Kirkland Lake Gold (KL), the most undervalued million-ounce gold producer, but otherwise am not looking to buy any miners at current levels. I’ve been bullish and adding to my position in gold and gold miners for several months now, but now that retail has arrived in full force, it’s time to be open-minded to a pullback.

The bulls will remain in control and this bull market is nowhere near over, but for those looking to add exposure, a better opportunity will likely present itself over the coming months.

Disclosure: I am long GLD, KL

Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

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The SPDR Gold Shares (GLD) was trading at $193.20 per share on Thursday morning, up $1.85 (+0.97%). Year-to-date, GLD has gained 35.20%, versus a 4.11% rise in the benchmark S&P 500 index during the same period.

GLD currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #1 of 34 ETFs in the Precious Metals ETFs category.