Gold: The Return Of The King?

All that is gold does not glitter,

Not all those that wander are lost,

The old that is strong does not wither,

Deep roots are not reached by the frost.

From the ashes a fire shall we woken,

A light from the shadows shall spring,

Renewed shall be blade that was broken,

The crownless again shall be King.

– J.R.R. Tolkien

(Source: Author’s Photo)

Just as Aragorn wandered through the wastelands, gold (NYSEARCA:GLD) has also been trying to gain its footing the past few weeks. The metal has seen the path of its bull market put to the test just like young Frodo and Sam in their quest to destroy the ring. Just as re-forging Anduril for Strider was a arduous task, thus is gold’s challenge to stay afloat among Yellen’s incessant squawking. Despite the saber rattling and a wicked 9-day decline for gold, the metal is still hovering above key support. All eyes are on Wednesday and it remains to be seen whether the bulls can pull off another Isengard triumph. A victory here would help the bulls repair Anduril, and allow gold again to be king.

In spite of the gold bulls being bulldozed the past two weeks, there’s a silver lining for the remaining longs. Losing streaks like the one we’ve just witnessed in the metal tend to be very rare, and forward returns are typically quite favorable. Taking a look at the below study by Steve Deppe, we can see that this is only the 10th time since the GLD’s inception that we’ve seen 7 consecutive down days. This signal was generated at the close on Thursday last week, and forward returns tend to be mixed and not all that impressive over the next 5 trading days. However, forward returns are exceptional when looking out 20 trading days from the signal. As we can see from the below table, the GLD has seen a positive return 8 out of 9 times after this signal over the past 11 years. The average return going forward 20 days is 4.20%, and the worst return of the 9 occurrences was (-) 1.53%. If gold were to behave as it has in past based on the average occurrences under this signal, we would come up with the following figures:

Price for gold on March 6th close: $1,254/oz

Lowest price traded between February 9th & March 6th: 1,185/oz

Highest price traded between February 9th & March 6th: $1,275/oz

Worst case scenario for March 6th close: $1,184/oz

(Source: twitter.com/SJD10304)

If this scenario were to play out like the past 9 signals, the price of gold would close on March 9th at $1,254/oz. The only losing occurrence in the past 11 years was a 1.53% which would result in a close at $1,185/oz on March 9th. Based on these statistics, the bulls seem to have the odds stacked significantly in their favor. While there’s no guarantee that forward returns play out like ones of the past, 10% of the time the bulls will have 2% downside from current levels, and 90% of the time they’ll have more than 4% in upside. In a few years of analyzing different studies, it’s rare to find any with forward returns as positive as these. Therefore while it’s slightly concerning to see gold breach what should have been support levels, it’s hard not to be optimistic here.

(Source: Daily Sentiment Index, Author’s Chart)

Moving onto sentiment data, the majority of the bulls have thrown in the towel and left Pamplona for higher ground. What was recently the running of the bulls as we sat at a 74% reading 3 weeks ago, has now become the running away of the bulls. The bullish reading has been halved since late February, and we are currently sitting at 38% bulls.

As we can see from the above chart, bullish sentiment (white line) for gold violated its uptrend last week and is now trying to regain it. The sentiment moving averages have rolled over and are now in decline which typically tells us that the commodity’s short term momentum has moved to neutral. Having said that, the fact that we continue to make higher lows in bullish sentiment means we still remain in bullish mode for this sentiment chart. As long as the late January low at 22% bulls holds, I remain bullish on gold here from a sentiment perspective.

(Source: TC2000.com)

Moving onto the technicals for gold, there’s no reason to get bearish just yet. The weekly chart for gold continues to make higher lows, and this continues to look like the beginning of a new bull market. Taking a look at the above chart we can see that gold broke out of a falling wedge and back-tested this level in mid December. I highlighted this level in my December articles as support for the metal and was the basis for me moving my portfolio to 45% long gold stocks.

The change in character for gold is very obvious from the above chart as this is the first time we’ve seen higher weekly swing lows since 2011. The December 2015 lows came in at $1,045/oz and for the time being we’ve made a much higher low at $1,120/oz. Until this pattern breaks, I see no reason to underestimate the metal. The uptrend line off of these lows comes in at the $1,150/oz level and I would expect this to provide support if this correction deepens. If we do breach the $1,150/oz level as support, then $1,120/oz is the last line of defense. I would not like to see $1,150/oz breached on a closing basis, and personally do not think it gets this ugly. Sentiment continues to paint a bullish picture for gold, and we still have higher lows in place from this year’s rally.

(Source: TC2000.com)

Zooming into the daily chart, we can see that the bears were waiting with sharpened claws for the metal at the downtrend line and the 200-day moving average. They’ve since put pressure on gold and even managed to push it beneath its rising 50-day moving average. Just as the top on February 27th began with a doji, we got a doji candlestick on Friday after a relentless 9 days of selling. Dojis are typically trend reversal candles when they come near potential swing highs or swing lows.


(Source: TC2000.com)

I do not use dojis in isolation and only pay attention to them if we see follow through in the direction of the potential trend reversal. As we can see the top for gold clearly got confirmation as it moved below the doji on February 27th, and thus far we are seeing some confirmation that this could be a trend reversal from the Friday doji. I would have preferred to see a slightly stronger close for gold today, but as long as the doji’s low holds on a closing basis, I will remain cautiously optimistic that the lows could be in.

(Source: TC2000.com)

Finally taking a look from a Fibonacci perspective, we can see that gold bounced from within pennies of its 50% retracement of the move off the December lows. The 61.8% retracement level comes in at $1,178/oz which also coincides with the late January swing lows. If we do see any further weakness in the metal, I would expect $1,175 – $1,180/oz to provide support. A pullback to the 61.8% retracement also lines up almost perfectly with the average drawdown after a 7-day losing streak in GLD, so as long as we can close above $1,172/oz a move down here would not concern me.

I am currently long gold from $1,176/oz with a half position, and my stop on this trade is below $1,172/oz. If gold breaks below $1,172/oz I will not be abandoning my miners, as they all have independent stops on them. This means that I do not care what the price of gold does in respect to my miners, and as long as my miners remain in uptrends I will stick with them. An example of this is Osisko Mining (OTC:OBNNF), Marathon Gold (OTC:MGDPF) and Nighthawk Gold (OTC:MIMZF) which are all up over the past few weeks despite a violent correction in the Gold Miners Index (NYSEARCA:GDX).

(Source: TC2000.com)

(Source: TC2000.com)

Just as Aragorn’s sword got a second lease on life, gold also should get a second chance at moving back into a new bull market. Losing streaks this the one we’ve just suffered lead to strong forward returns, and bullish sentiment continues to make higher lows. I see no reason to lose sleep over this gold trade until $1,172/oz and $1,150/oz are breached to the downside. These would both be very negative developments and would only leave the bulls one out at $1,120/oz.

I’ve been re-deploying my cash the past week into miners and picking up several names on my shopping list. This has moved my miner allocation from 30% in the first week of March to a current weighting of nearly 45%. My top 3 miners based on their weightings in no particular order are:

Seeking Alpha has modified the way they tag articles, therefore if you are not “following me”, you will not receive notifications of my articles. If you would like a real-time notification of when my new articles are published, you will need to select the “Follow” button at the top of my article.

(Source: CIBC Investors Edge Account)

For full transparency I have shown my account above so that readers can see my money is where my mouth is. To keep my new positions private, I will only be sharing my smallest portfolio going forward out of respect for my premium newsletter subscribers.

Disclosure: I am/we are long GLD, OBNNF, SEMFF, TORXF, MGDPF, MIMZF.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: If you liked this article and found it useful, please feel free to follow me by clicking on my name next to my avatar at the top of this article. I also invite you to follow me at www.twitter.com/TaylorDart01 where I routinely share my entries, exits, and stops on new positions, as well as updating followers on sentiment data on markets I am following.