Gold: The Bulls Must Hold Here

It’s been a disappointing couple of months for investors in the precious metals space, with gold (GLD) tumbling 10% from its highs and most of the gold bugs calling for $3,000/oz before year-end nowhere to be seen.

This moderate correction in the metal has many investors scratching their heads as we continue to see no real opportunity cost for holding the metal given the record treasury rates and a stance on monetary policy that could not be more dovish.

Unfortunately, while the fundamentals are important to the gold trade on a long-term basis, they are meaningless in the short-term, with sentiment typically dictating the path of least resistance. Given that bullish sentiment hit multi-year highs as we entered August, it’s no surprise that the metal has struggled, but the good news is that we’re finally seeing a sea change in sentiment as we exit October. Let’s take a look below:

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

As we can see in the chart above, bullish sentiment spent nearly three months trading above the 80% level, suggesting that 4 out of every five investors were bullish.

An increase in bullish sentiment often leads to higher prices, but when that trade is persistently crowded over a long duration, no one is left to buy. In the past, sell signals bred from excessive optimism have led to 8% plus corrections in the metal over the following three months, and this is precisely what we’ve seen since August. Fortunately, this very normal decline after a 43% rally off of the March lows has taken a massive bite out of bullish sentiment, with this indicator now hovering below 30% bulls.

Given that gold is still sitting within a stone’s throw of its previous all-time high, this is a very positive sign. The reason is that investors are now getting overly pessimistic on the metal even though it’s done absolutely nothing to suggest the all-time high breakout has been negated.

Beginning with the Gold vs. S&P-500 (SPY) ratio, we remain in bullish territory, and this would not be the case if gold had forfeited its bull market status. As shown in the chart below, this indicator (blue line) made a bullish breakout above its long-term moving average (white line) earlier this year, and we remain above this moving average despite the 3-month correction we’re in.

Typically, the metal has performed its best when it is leading the S&P-500, and it’s during these times when it’s best to give the metal the benefit of the doubt. Therefore, while the correction has likely been frustrating for many, especially those that filled up their portfolios with miners near the highs, it’s important to note that sharp corrections are normal but are generally noise as long as they remain above the key moving average for this indicator. Until this changes, I see no reason to give up on the metal.

(Source: TC2000.com)

If we look at strictly gold from a technical picture, we also see encouraging signs, as the metal remains above its 200-day moving average (yellow line). The good news is that this 3-month correction has allowed gold’s 200-day moving average to catch up to the price, and generally, this level has provided strong support during bull markets.

In addition to this, we can see that gold is sitting less than 1% below its previous all-time high set at the 2011 bull market peak, and it has seen a drawdown of less than 5% below this level. If this were indeed a failed breakout, we would expect gold to trade more than 10% below this level and to sit there listlessly with no buying support.

(Source: TC2000.com)

As of Monday’s close, this is not the case, as we have found buying support almost immediately on sharp corrections to $1,860/oz. Given that the 200-day moving average should be at $1,800/oz by the election, and sentiment is already in the pessimism zone, I believe any further leg down in this correction to below $1,825/oz is likely to provide a buying opportunity. In fact, it’s possible the metal has already bottomed and is simply shaking out more weak hands while we await the Presidential Election results.

So, what’s the best course of action?

For investors bullish on the metal long-term, there is no reason to give up positions because of a run-of-the-mill 11% correction. In fact, we typically see corrections of this magnitude on gold twice a year, and even during bull markets.

Some investors might have forgotten this after being hypnotized by calls of $3,000/oz by year-end. However, I find it very encouraging that the usual suspects slapping lofty price targets on gold have quieted down, and many investors have begun to turn bearish just because gold is consolidating. In summary, I see the best course of action as holding, and I see no reason to doubt the recent all-time high breakout unless we lose $1,760/oz on a monthly close.

For now, I remain long gold (GLD) and a couple of miners, and I may look to add to my position if we see further weakness in the metal before year-end.

Disclosure: I am long GLD

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 $179.00 per share on Tuesday morning, up $0.45 (+0.25%). Year-to-date, GLD has gained 25.26%, versus a 7.03% 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.