Trader’s Narrative

Now that the short term bounce in gold stocks is over, its time to take another look at the whole precious metals sector. Within the AMEX Gold Bugs Index (HUI), the % of stocks above their 50 day moving average is at less than 10%. This is incredibly oversold in the short term. The last time we were saw a reading this low was April 2005 when gold stocks put in a major bottom and proceeded to almost double from 170 to 300.

But (you knew there would be a but, right?) back then, the % of gold stocks in the HUI above their 200 day moving average was also very low. In fact, it was around 10% above the long term moving average. So in April 2005 the precious metals sector was oversold both in the short term and in the long term.

That is not the case now. The % of gold stocks above their 200 day moving average has been stuck stubbornly between 75 and 80% during this whole correction. That is way too high for us to see any meaningful rally develop. Leaving the internal breadth of the sector and turning to the HUI itself, things don’t look any better:

Did the short term bounce in late May carve out the right side of a head and shoulder top? If so, the measured move and target would be in the 245-250 area. Which also corresponds to a support level (previously resistance). The HUI may not necessarily fall to that level in short order - it may not even be finished with this right shoulder since things are oversold in the short term.

Secular bull markets put in serious and vicious corrections to throw off as many people as possible. In the 80’s the gold bull did its utmost to shake off the longs. Can you imagine a 50% correction? That’s what traders had to endure then if they wanted to hang on to sell at the top. So far though, this generations’s gold bull has been pretty stable and predictable. Can you imagine a 50% drop in gold stocks now?

Two final data points are the massive net short position by commercials in the Euro and the sharp u-turn taken by the commercials in the Swiss Franc unwinding their large net long position and going net short. So putting it all together, my thesis right now is that we’re going to see a downward move in gold stocks. Not necessarily a whoosh, but more likely a grinding down over a few months. It would make sense that gold would then bottom and rally in the seasonally strong August to October months.

Until then, I’ll be looking for shorting opportunities in gold stocks, especially those that are weak relative to the HUI like NovaGold (NG).