Trader’s Narrative

Gold futures (December contract) closed higher at $709.70 an ounce today and dragged with it gold stocks. While many journalists claim it was today’s atrocious jobs data, I doubt it.

That explanation may be neat and tidy but it is useles since gold and gold stocks started this short term rally a while ago, before any attention was focused on economic data.

Most probably the real reason why the gold sector has been doing well lately is that it was extremely oversold. In mid-August when I wrote about gold and gold stocks getting clobbered, I ended by saying:

…right about here I think gold stocks are ripe for an oversold bounce. Nothing fancy, just a tradeable rally.

Within the Gold Bugs Index (HUI) zero gold stocks closed above their 10 day and 50 day moving average. And only 7% closed above their 200 day moving average. Wouldn’t it be hilarious if gold stocks rallied along with the stock market?

Maybe not as hilarious as profitable. Hope you got yours.

Now the gold bugs are getting excited but I find no reason to join them in believing that gold is going anywhere in the medium to long term. For one, it has worked off a very extreme oversold technical condition. Now we have 50% of gold stocks above their 200 moving average. When I told you about this upcoming bounce there was only around 10%.

The other reason is that both gold and gold stocks are still mired in a trading range. By the time they make it up to the upper resistance level the technical picture will be overbought and they will get slapped back down again. Had this mid-August technical oversold condition occurred when the AMEX Gold Bugs Index (HUI) was just below 400, things would be very different.

The final reason is that according to the k-ratio that I’ve mentioned many times, the gold bull market is over.

As I ponder the dollar reaching its long term support levels, I can’t help but wonder how things look for gold stocks long term. My favourite indicator for the precious metals sector is the k-ratio.

It is the price of gold stocks divided by the price of gold. I prefer to use the AMEX Gold BUGS Index (HUI) since it is a true gold stocks index. BUGS is a pithy acronym that actually stands for “Basket of Unhedged Gold Stocks”. In contrast to other gold indices like the Philadelphia Gold and Silver Index (XAU), HUI is neither hedged nor has any exposure to other metals like silver and copper.

k-Ratio
Anyway, the price of gold closed at $684.70 and the HUI at 370.23, which gives us a ratio of 0.541

While the longs may be happy when gold stocks go up, if gold itself doesn’t move in proportion to equities, there can be no serious rally in the sector. In fact, the higher gold stocks go without a concomitant rise in the price of gold itself, the more probable that they are riding on fumes and carving out a top.

While the spot price of gold has yet to reach the swing high in April 2007, the Philadelphia Gold BUGS Index (HUI) has just surpassed it. If this sort of disconnect continues, either the price of gold has to run up to catch up, or the gold stocks will fall to realign with the commodity.

Anything is possible in the market. Precious metal equities could pop higher. But at these levels, if you’re a long term investor, it is time to take profits, not put new money to work. That time was at the turn of the millenium, when the k-ratio made an all time record low: