Trader’s Narrative

The AMEX gold bugs index has bounced back, finding support at the 280 level exactly where it did so before in March 2006. This caught me off guard since I was bearish on the sector. But there’s been a concomitant rise in bullish sentiment which does not bode well for the gold sector; atleast in the short term.

According to Mark Hulbert, the sentiment picture has changed too quickly for this bounce to have any more legs. His Hulbert Gold Newsletter Sentiment Index - a calculation of the average recommended exposure in the sector by gold timing newsletters - shows a jump of more than 70 percentage points in only nine trading sessions. This is the biggest nine day jump in many years.

With such a rush to get back into gold just as it has bounced off intermediate support, things don’t look that good. Bulls should ideally see a skepticism if this rally is to have any endurance.

As well, the k-ratio has increased to levels where gold stocks have hit resistance in the past. Here’s an explanation of the k-ratio, in case you’re not familiar with it.

One of the reasons why I was bearish on the sector was breadth. At that time, the % of gold stocks above their long term moving average was still quite high. But immediately after I wrote that, that percentage fell very quickly from 75% to 20%. This breadth washout was so rapid it took me by surprise. So it was understandable that with such a dramatic deterioration in breadth and with gold itself kissing its 200 day moving average we would see a swing bottom in the middle of June.

But similar to the sentiment picture, this metric has turned around just as quickly as it fell. Now just a few trading days after, we again see the breadth showing 100% of stocks above their 200 moving average. The probability of a rally continuing with such an overstretched breadth is extremely low.

In fact, the probability is that we’ll see either a pause here or a retrace. If HUI does fall from these levels, it could carve out an almost perfect head and shoulders with the 280 level being the neckline: