Gold Sentiment Reaching Bearish Extremes

We’ve seen a relatively normal correction over the past two months for gold (GLD) from its new all-time highs, but despite this moderate pullback, investors look to be giving up on the metal.

Based on Monday’s readings, bullish sentiment on the yellow metal is now lower than in December 2019 when gold was sitting $400/oz lower below $1,500/oz.

These recent readings suggest that many were likely caught buying the metal well above $2,000/oz in August, and are now being shaken out of the trade as few rational people would be pessimistic on an asset class that’s up over 27% year-to-date. Let’s take a closer look below:

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

As we can see from the chart above, the metal headed back into the danger zone (red box) in August, as bullish sentiment soared to above 90% bulls and the 20-week moving average for sentiment headed above 80% bulls.

In the past, this has been a very bearish signal as the metal has typically seen a draw-down of 8% or larger after trading inside this zone. Two months later, this signal has played out almost exactly as expected, though the correction has been a little deeper than the norm. Given the decline, the sentiment moving average ha slid from 85% bulls to 60% bulls, and this is nowhere near the extreme pessimism zone that often leads to multi-year buying opportunities.

However, it’s important to note that we’ve only headed inside this zone on eight occasions in the last 12 years, and never came remotely close to this zone in the 2010-2011 period when gold was consistently making new all-time highs. Therefore, while a mean reversion is undoubtedly to be expected as we’ve seen, a pullback into the green box (extreme pessimism) is highly unlikely.

If we zoom in on bullish sentiment, we can see that we have much more pessimism than the above chart would suggest, with bullish sentiment sliding below 30% last week. This is a massive sea-change from what we just saw eight weeks ago when we had 9 out of every 10 market participants bullish and calls for $3,000/oz before year-end. As noted earlier, bullish sentiment on gold is now below its March lows during the COVID-19 Crash, and below its Q4 2019 lows, even though the metal just hit a new all-time high last quarter.

These readings are quite puzzling, as we would expect an asset class that is making all-time highs to have more bulls than bears, not 2 bears for every 1 bull like we have currently. Therefore, even though these readings have not headed into the buy zone (green shaded area), valuation is becoming a tailwind given where the metal is relative to past corrections (all-time highs vs. 6-month lows). Let’s see if any technical damage has been done to the metal that might explain this heavy dose of fear:

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

(Source: TC2000.com)

Moving over to the yearly chart above, we can see that gold blasted out of a 5-year base last year and has seen significant follow-through this year, slicing through the previous all-time highs like they weren’t even there.

Since then, the metal is hanging out right near its previous all-time highs, and weakness below $1,900/oz was bought up almost immediately. This is not bearish price action by any means, and I see no reason to be bearish on the metal unless the metal breaks down through old support at $1,765/oz, which would be a significant change of character.

It’s important to note that this does not rule out a further pullback in the metal and a final drop towards the $1,800/oz level. However, investors should be encouraged by the fact that gold is near becoming a hated trade if this correction continues.

So, what’s the best course of action?

(Source: TC2000.com)

I continue to remain long from an average price of $1,500/oz~ and I may consider adding to my position if we see signs that this short-term correction is over. For now, I continue to accumulate the best gold producers like Kirkland Lake Gold (KL) and Endeavour Mining (EDVMF) on weakness, as both have recently broken out of massive bases and are trading at less than 12x FY2021 annual EPS.

These are enormous discounts to the sector average despite strong double-digit earnings growth, and I would expect these stocks to trade 40% higher over the next 18 months. As long as the bulls remain overly pessimistic like they are currently, it’s time to be open-minded to an end to this correction during Q4 for the metals. The best-case scenario would be a dip below 20% bulls on sentiment, but even at current sentiment levels, there is a possibility that the metal has already bottomed at $1,860/oz.

Disclosure: I am long GLD, KL, EDVMF

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 $177.47 per share on Tuesday afternoon, down $3.09 (-1.71%). Year-to-date, GLD has gained 24.19%, versus a 10.58% rise in the benchmark S&P 500 index during the same period.

GLD currently has an ETF Daily News SMART Grade of B (Buy), and is ranked #9 of 34 ETFs in the Precious Metals ETFs category.