A Reasonable Risk-Reward Proposition

Obviously today’s FOMC decision (we are writing this shortly before the announcement) could result in a lot of short term volatility, but we nevertheless wanted to briefly remark on the gold sector’s technical situation. Here is a chart of the HUI (daily) with RSI and the HUI-gold ratio:

Click on picture to enlarge

HUI daily and the HUI-gold ratio – a number of divergences have been recorded recently – via StockCharts

As you can see from our chart annotations, while the HUI has been oscillating near its lows, a number of (usually positive) divergences have been put in. The short term risk-reward situation is begging to be exploited. The recent lows near the 104 level are not very far from current levels, and can be used as a risk control level, a.k.a. a “stop”. In short, near term risk can be minimized as long as the index remains above this level.

Last Friday, this support level was briefly broken to the downside (the candle with the long lower shadow), but the index ended the day in positive territory and back above support. It is this event in particular that makes the current situation intriguing from a short term perspective.

On the other hand, should the market break this support level decisively in the days after the FOMC announcement, one would probably have to wait for a typical cyclical October/November low to form (it is unknown why, but the sector frequently produces medium to long term turning points in May/June as well as October/November). This year things are probably skewed though, due to the widely expected rate hike.

Conclusion

There is no need to know in which direction the index will break, as risk can be clearly defined from a trading perspective. At the same time, the recent at least theoretically positive divergences are making it an even better risk-reward proposition. As a final remark, in light of the decline in input costs (primarily energy, but also other consumables and an end to labor market pressures), the ratio of the HUI to gold should actually rise over time.