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Gold Reacts To Bullish Extreme Sentiment (Finally)




At the start of October I wrote about the extreme in gold sentiment bullishness which was a sign of an impending top in the precious metal. Gold was able to continue to push forward for another two weeks or 9 trading days, reaching a closing high of $1381 on October 14th 2010.

Here's what I wrote back then:

Positive seasonality will continue to provide wind to the back of gold bulls for two more weeks. So it is possible for gold to eke out an even bigger gain yet. But the incredible streak of positive days that has propelled the yellow metal higher as well as the rising bullish sentiment is telling us that we are near a top.

That makes me sound like an oracle! But before that prescient call goes to my head, let's take a new look at where gold stands now. Since last week, gold is down and it looks like a significant top has formed. Of course, the gold bulls had more than just bullish sentiment to worry about.

The technical picture was also over-extended with relative distance of the price of gold to its 50 day moving average quite high. As well, the bullish percent index was at 80%, near levels where we had seen significant tops. With the fall in prices, both of those measures have ameliorated as expected.

The sentiment data continues to signal a major top. Here's a chart of the Daily Sentiment Index for gold (10 day moving average) showing that at these levels we see either a decline in prices or at best, a sideways congestion to work through the rally that has just preceded it:

gold sentiment DSI Oct 2010
Source: RMG Wealth (data from trade-futures.com)

As well, it is normal to see the technical measures like the bullish percent index and the relative distance from moving averages to return to more normal levels. This does not however preclude a continuing decline in gold prices.

Back in September, I referred to the muted Rydex Precious Metals fund asset levels as a reason why the rally would continue. A reader suggested I use the aggregate asset levels from all the various different classes of Rydex precious metals funds so here is a chart of just that along with the comparison chart of the Gold ETF (GLD):

Rydex precious metals assets NAV Oct 2010

As the chart shows, we did get to a spike of $281.5 million in assets. That isn't as high as previous times, for example, in December 2009 but is still in the general area that has previously coincided with major gold tops. As you'd expect, Rydex traders have exited from the fund in response to the lower prices. Again, that's something that we'd expect and it does not prevent a top from forming.

There are two other measures which suggest that we might see a very shallow correction or perhaps a sideways congestion instead. The first is the Central Gold Fund's (GTU:NYSE) premium/discount. As a closed end fund this metric tells us how enthusiastic people are about gold to the point of being willing to overpay to own it. The normal trend is to see the premium expand when gold is rallying and to see it contract and fall into a discount when the price of gold is declining.

central gold trust premium discount graph Oct 2010
Source: Decision Point

For the first time since September 2008 Central Gold Fund fell to a discount. This is very unusual and suggests that retail traders are overreacting to the price decline since October 14th. Also, note that the premium has been in decline for some time, even as gold was breaking out to new highs. So in essence, this measure of retail sentiment shows a rather surprising lack of enthusiasm.

The other counter argument against a continued decline is from the Hulbert Gold Newsletter Sentiment Index (HGNSI). After the decline it was 59.2%, meaning that the average exposure recommended by the newsletters that try to time gold is to be long the gold market with almost 60% of a portfolio. Considering the size of the rally we've just witnessed this is relatively modest. Back in December 2009, the HGNSI was 68%, much closer to what we would normally consider to be an extremely high level.

Conclusion
Based on these various sentiment gauges it is possible that we have seen a major top for gold but that in response gold will not decline heavily. Instead, gold could see a shallow retracement and enter into a trading range as it did from March 2009 to August 2009.

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5 Responses to “Gold Reacts To Bullish Extreme Sentiment (Finally)”  

  1. 1 Zeb

    The US dollar sentiment is the real story. Gold sentiment doesn't mean much since it isn't as heavily traded of a market. With dollar bears being less than 3% a few weeks ago, I don't see how that's could be good for gold in the big picture. That sounds like a major bottom in the dollar, which under normal circumstances would cause a major top in gold. I'm expecting gold to trade down below $1,000 oz, perhaps to the typical run rate of $600/oz, in less than a year.

    We are fully expecting the "fear" trade to capitulate within a year. This is a complete abandonment of all risk assets by retail investors, leaving banks and the Fed holding the bag, which will cause an in-fight collapse in the capital markets. It is already starting to play out in the MBS markets, just as we expected. They're all holding garbage, and they're trying to unload it or get someone else to pay for it. Unfortunately, no one in the retail investing community OR even the hedge fund community gets what is really happening.

  2. 2 Tiho

    Everyone gets what is currently "happening", but the musical chairs game is played until the music stops. And it hasn't stopped yet, has it?

  3. 3 Suma Barlo

    Good stuff... as usual.

    Do you see GLD down to 123.50 on this reaction? In December 09 it came down 15 points to support at 104, and it caught up with its 200 WMA...

  4. 4 DoctoRx

    Babak: In your Oct 1 gold piece you wrote:

    Not surprisingly, the retail investor is clamoring to get on board the gold bandwagon. According to TrimTabs, the SPDR Gold ETF (GLD), year to date has had inflows of $6.7 billion which is a 35% increase in its asset base.

    We know however that even Soros invests in GLD. How much data do you have about how much of GLD's inflow is from retail vs. institutions?

  5. 5 Mike C

    I’m expecting gold to trade down below $1,000 oz, perhaps to the typical run rate of $600/oz, in less than a year.

    I'll sell you as many 1-year 700, 800, 900 strike price options as you want. Unless we see some dramatic shift in government fiscal and central bank monetary policy to substantial real rates of positive return, we won't see sub 1000 prices again.

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