A Negated Breakdown

There have been remarkable gyrations in the gold sector lately. The typical rebound out of a November/December low (typical in recent years after the end of the tax loss selling period) was initially cut short in January in the course of the global stock market decline. This was a bit surprising, because it was widely held that the recovery in the gold price was a result of said stock market decline.

Photo via genius.com

We suspect that in it was initially still widely expected that stock market weakness was just a fluke and that the downtrend in the gold price would therefore soon resume. Moreover, base metal mining stocks were pounded mercilessly and as we have previously discussed, there is a completely illogical short term correlation between this sector and gold mining stocks, likely due to various tracking products and the mindless automatic buying and selling associated with them. From a technical perspective the action has created quite an interesting situation though:

XAU and HUI daily. After initially beginning to recover from November, resp. December lows, both indexes sold off sharply after the first trading week in January, and in the process broke below a previous support level that has been tested many times and has up to that point always held. It looked like yet another breakdown in the long-lasting bear market was underway – but the indexes quickly reversed back above the broken support line – click to enlarge.

As the chart annotation indicates, the recent reversal is definitely positive. Both false breakouts and false breakdowns often turn out to be reliable trend change signals. An additional bonus in this case was that the initial breakdown has induced widespread capitulation (judging from anecdotal evidence).

Advance in Gold Characterized by Caution

What looks encouraging as well is the recent saucer-shaped bottom in gold – usually this kind of formation leads to a fairly decent rally:

Gold begins to rise out of a saucer-formation – click to enlarge.

Contrary to the immediately preceding rally attempt, the current one has been a “scared rally” so far. There has been fairly little speculative buying in COMEX futures, and small speculators have actually remained net short up until last week, when their net position turned roughly neutral.

Speculative buying in COMEX gold futures has so far been far more subdued than during previous rallies – click to enlarge.

The mainstream financial press is still busy penning obituaries on gold, which is generally a good sign as well. A playable rally should be widely disbelieved in its early stages. According to the article we have linked to “many still don’t see a bottom”, but in terms of major non-dollar currencies it has of course occurred a few years ago already. In numerous EM currencies gold has in fact attained new all time highs, but even priced in major developed market currencies the performance of the gold price continues to diverge significantly from that in USD terms.