Let's take a look at GDX (large caps) and GDXJ (juniors). In the following chart we show both along with the bullish percent index for the sector, which is at 40% but often bottoms at 25%-30%. For GDX we note strong support at $48 and $50 with support at $51. Meanwhile, GDXJ remains above key support at $34. Should that falter we are looking at $31.50–$32 as the next support.
Whatever bullish sentiment there was at the end of 2010 has completely eroded. Assets in Rydex Precious Metals Fund are near an 18-month low and very close to a two-year low.
We should also note that sentiment on gold itself is not so bullish. Mark Hulbert's HGNSI indicator, which was 70% at the recent top, fell to 7% at the recent bottom and now is only 20%. Yes, with gold only 3% away from a new all-time high, the average market timer recommends mostly cash instead of a long gold position. Further, open interest in gold futures is 22% off its high and the speculative long position is 21% off its high.
Technically, the gold stocks are in a good, low-risk position. However, there needs to be a fundamental catalyst for the sector to bottom, build a base and embark on a new sustained advance. Strengthening of gold's real price always helps, though its effect is not immediate and usually lags by a few months.
In the following chart, we graph gold against other markets. Similar to 2008, we can see the gold stocks falling against gold—yet gold is quietly strengthening against oil, industrial metals and the S&P500. The real price of gold began to strengthen across the board in September 2008 and it was only a month later that the sector bottomed.
As growth and deflation re-emerge as the primary concerns, we will see gold continue to strengthen against all markets and assets (sans Treasury Bonds). That is a positive, though not immediate, catalyst for gold stocks. The worse the economic numbers and conventional assets perform, the more likely the Fed will continue to provide increased artificial support. Moreover, the strong Treasury market provides the Fed political cover and the ability to monetize bad debts. It wants to do this when bonds are strong.
To conclude, there is no immediate catalyst for gold stocks but things are starting to move in the right direction. As the economy stalls and the equity market peaks, more money will move out of risk assets and eventually into gold, and then gold shares. We are already seeing the start as gold is firming in relative terms. Look for a bit more weakness in the gold stocks but ultimately this summer should host a major low, and gold stocks will be in a fantastic position heading into 2012.
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Jordan Roy-Byrne, CMT