Tuesday, February 19, 2013

When To Buy Gold (Timing The Market & Indicators)

Keep in mind that this blog is the opinion of the author and should not be taken as investment advice.

While I don't trade precious metals on a short term basis, I do keep a close eye on the charts and other market indicators in order to increase my positions (using some corrections to "buy the dip"). I've been more or less "all in" on precious metals since catching the lows through the middle of 2012, but have been able to add a small amount to my positions a couple of times since. Some medium to long term holders of precious metals prefer to dollar cost average their purchases (e.g. buying monthly regardless of price), but I prefer to time my purchases using a combination of the below indicators (which have served me well)...


Sentiment (contrarian indicator)

There are a couple of sentiment indicators available including Market Vane & Hulbert Sentiment. They are essentially tools which track what other market participants are doing and form a simple to read measurement which you can use as a contrarian indicator (do the opposite of consensus). There are subscription services you can pay for or just keeping your eye on various blog sites can score you recent updates on the sentiment charts for no cost (as an example, Tiho from theshortsideoflong.blogspot.com often posts them, as does acting-man.com).

Here is a description of the Hulbert Sentiment tracker:
The Hulbert sentiment indexes for Stocks, Bonds and Gold are courtesy of Hulbert Financial Digest.

This service was started by Mark Hulbert, in order to track the performance of hundreds of investment newsletters.  On a daily basis, Hulbert's team monitors all the newsletters they follow and determines the net long or short exposure of each letter.  We update the charts on our site weekly - for daily data, please visit their service directly.

They then aggregate that data to construct their Hulbert Sentiment Indexes, which is what we show on the site.

The net exposure among newsletters can vary from 100% net short to 100% net long, though in reality most newsletters are biased to the long side, so there is usually a long-side bias to the sentiment indexes.

This data is considered to be a contrary indicator when it reaches an extreme.  As noted above, newsletters tend to be long-biased, so whenever we see a net short exposure among them, it tends to be a decent buy signal for the underlying market.

Conversely, when newsletters are lopsidedly bullish, the underlying market tends to under-perform going forward.
Essentially you want to be doing the opposite of the crowd. So when the crowd is bullish on Gold you should be lightening up on positions (or holding, waiting for better opportunities to add to existing), when bearish, loading up (buying). Here is a recent chart showing how the sentiment peaks lineup with the highs in Gold and sentiment troughs lineup with lows in Gold.

Gold Sentiment Chart (Click to Enlarge)
The above was a snapshot from last week. It's likely that Fridays washout in Gold saw public opinion dip even further, providing an even stronger buy signal (similar to which we saw around the start and middle of 2012 when Gold was trading in the low $1500's).

Technical Analysis (price/chart)

I would consider price and chart analysis the least important of the four indicators I predominantly use. The price tells you next to nothing without proper context.

A chart can be open to multiple interpretations (depending on where/how you draw the support/resistance lines and the patterns you choose are most important), take the below for example:

Gold T/A Chart (Click to Enlarge)
We can see that $1625 was an important level. It was an area of resistance through mid 2012 and then support earlier this year when we saw it tested in early January, however ultimately it sliced through this last Friday and bounced off the next resistance which was the bottom of the downtrend channel. A scalper who happened to be trading at the time of the $1625 break might have picked up an easy $20 by shorting Gold on the drop below $1625 and buying back when the next, but most likely there were a large number of traders with stops just below the $1625 area which were cleared out in the one day plunge.

The commercial traders will often be found to lighten their short positions, increase their longs as they squeeze contracts out of the hands of speculators and traders who have their stops around important technical levels.

I tend to buy in the case of one of two events (provided other indicators also point to a good buying opportunity):

1. When Gold drops sharply to a level of strong resistance and bounces (so I was a buyer when Gold recently dropped to $1625 and support held and also with Friday's drop to $1600).

2. When Gold drops sharply through an important technical level, but then recovers quickly, bouncing back on the same trading day (signs of an obvious stop run where the buying pressure underneath is strong enough to drive the price back above support). We saw several of these events over 2011/2012 where the price dropped below important support at $1550 for less than a day or two.

If Gold breaks through important support areas and doesn't show quick signs of a recovery it often means further weakness is ahead.

Volume (capitulation)

When Gold breaks to the downside through important technical levels as discussed above it often does so on heavy volume as the price plunges, clears out stops and scares weak hands out of the market. This is the signs of the short term speculators capitulating, exiting their positions and traders being stopped out. 

Generally higher volume will be seen in the troughs as well as the peaks as most market participants will chase or capitulate at exactly the wrong times:

Gold Volume Chart (Click to Enlarge)
A large spike in volume (as we saw last Friday) doesn't guarantee the low was on that day. As we saw through the middle of 2012 (May/June) we had elevated volume for a period of time as Gold carved out the bottom, building support before moving back to higher prices.

The charts used for price and volume activity are from Stock Charts.

Commercial Positioning (COT report)

Unfortunately the Commitment of Traders (or COT) report is not timely enough to use when taking a position within a day or two of a suspected bottom. When released on a Friday it's data only reflects to the Tuesday prior, making it a late indicator, but a useful one for confirmation following a purchase. The trend is usually pretty obvious as well. See the below chart:

Gold Volume Chart (Click to Enlarge)
What I'm looking for in this data is positioning of the commercial traders (that is the bullion banks such as JP Morgan, HSBC & others). They retain a permanant net short position in Gold, but as you can see they significantly reduce their net short position as the price falls (see green lines) and increase it as the price rises (see blue lines).

As can be observed in the chart the net short position has been reduced to a level of previous price lows (see orange line) and the further shakeout on Friday has almost certainly reduced the commercial net short position even further. This points to a bottom in price likely in or very close.

You can view the latest COT reports here on Goldseek (posted every Friday, data current to the Tuesday prior) and the above chart was from Bar Charts.


So in summary the four indicators I watch show that sentiment on Gold is bearish (bullish for price), the price of has bounced strongly off support at $1600 and if it does slip lower there is further support around $1550-1575, volume on Friday suggests capitulation (a sign of a low or a bottom forming) and the commercial positioning also suggests that it's time to buy.

If the last three occasions where we've seen where these indicators align are any sign of where the price is heading we can expect a rally in the vicinity of $150-200 in the near future. Such a rally would break us out of the downtrend channel and likely set us on course to breakout to new highs later this year (in my opinion).

The above indicators will only continue to help while Gold remains in a secular bull market where the buyer has the patience to ride out the longer term trend and allow it to correct any timing mistakes. Use them at your own risk.

A couple of other observations that I've made that are worth noting:

Gold / Silver Ratio

The Gold:Silver Ratio (GSR) has not bounced as high this time around, indicating that Silver is holding up better than the three other times the above indicators pointed to a buying opportunity. See below, Dec 2011/Jan 2012, May/June 2012 & Dec 2012/Jan 2013 we saw the GSR peak above 55, but the current correction still has it below 54.

This could in part be due to the large demand for physical Silver which saw the US Mint achieve a record month of 1oz coin sales in January 2013 and also saw the Mint run out of blanks to press new coins.

It suggests that either Silver could be ready to outperform Gold again when it bounces back, leading the strong advance as it did in 2011 or it could mean that the price correction is not yet over and further downside could see Silver slide heavier than Gold in the short term. After two years in the doldrums and still some 40% below the early 2011 highs I am thinking there is a good possibility that it's the former and I am positioned aggressively with the SLV call options to benefit from strength in Silver over this year and next.

Inverse to Stock Market

Gold has started to trade inversely to the stock market as put by The Rothbardian Investor (a new contrarian investment blog I have enjoyed reading):
We’ve been delighted to see a resurgence of the historical negative correlation between equities and gold, which was thrown under the bus during this last cyclical stock bull. It’s now obvious that gold is again ready to act as a “risk-off” investment, as it is fundamentally designed to do (and as in fact did in many prior instances, both recent and remote). The Rothbardian Investor
Here is a chart showing that through the middle of 2012 Gold and the stock market moved together as risk assets, rising and falling mostly around the same times, but late in 2012 they started to diverge.

S&P 500 (blue) vs Gold (red) (Click to Enlarge)
While this has resulted in short term price weakness in Gold it also sets up the potential for a powerful counter trend rally in the metals should the stock market peak and roll over, especially if market participants are looking for an oversold sector to pile into...

It's been a long time coming, but I think the continuation of the Gold bull market (i.e. new highs) is close. It has certainly tested the patience of many. I've seen a few burnout waiting with some previously bullish now turning into bears, it's observation like this while we remain in a fundamentally positive environment for Gold (negative real rates, abuse of fiscal and monetary policy) that make me even more bullish for the rally that I believe lies ahead... as I've recently written I believe we will see the price of Gold rise above $2000 this year, possibly as high as $2300-2400 and I think Silver will be along for a great ride too.

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  1. Thanks for the nice reference to our blog.I also enjoy reading yours.
    It is indeed about time to buy PMs(we actually think gold looks more appealing):let's see how they act today and for the rest of the week.
    There surely are many signs of capitulation.
    Some of the less crappy miners also look very attractive.

    1. Thanks. And agree there are some very undervalued miners. The XGD (Australian Gold stock index) is back to late 2008 levels.

  2. My eyes often glaze over when reading technical analysis on gold / silver as I mostly prefer reading about fundamentals and macro stuff... but this post was an exception to that rule. I might use these tools to time my buying in future... I hope you're right re: a bounce this year. Have been patiently waiting

    1. Most T/A tends to look at opportunities for trading the short term, so definitely understandable that those with a longer term fundamental/macro strategy would sometimes find no common ground with charts, but I do think keeping an eye on some indicators worthwhile for timing the top ups ;)

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