Turning Bullish On Gold & Gold Stocks For A Trade

After flagellating myself for too much bearishness, the last time I wrote about the yellow metal I mentioned that I would be returning to it when it presenting a buying opportunity:

The best combination of breadth is strong long term (200 day average) and weak short term (10 and 50 day moving average). A good example was in mid December 2007 when there were only 10% trading above their 50 day MA and 5% above their 10 day MA with a very high 60% above their 200 day MA.

I’m keeping a wary eye on this sector until it presents a similar setup and will post about it.

After its top in March, the Philadelphia Gold Bugs Index (HUI) fell almost 20% in the span of a few weeks. And since I was distracted, I missed the opportunity to write about arriving at the exact oversold condition that I described above.

But since things haven’t significantly changed in this sector, let’s have a look. The commodity itself fell from a high of almost $1034 to $876 and it pulled down gold equities with it:

Gold Sector Breadth

We now have almost 60% of gold stocks trading above their 200 day moving average. So as described above, the long term is still in good shape.

And the short term is weak: in early April, only 10% were trading above their 10 day moving average. Similarly, only 20% were trading above their 50 day moving average.

Since then of course, they have moved up slightly but neither is so far extended to remove the oversold opportunity.

Gold Bullish Percent

The recent decline in the Philli Gold Bugs Index (HUI) also caused the bullish percent index (BPI) for the sector to kiss the 30% line iin early April 2008.

Historically, when the bullish percent falls to this level or lower it is a good time to “rent” some gold stocks. The previous instance was in January 2008.

Since there is nothing magical about this 30% area, the BPI can crash through it to reach significantly lower levels. For example, in October 2007, the gold BPI fell to almost 15%.

Getting back to today’s conditions, since earlier this month the BPI has recovered along with gold and gold equities. But we are still at a low enough stage that catching and riding a rally are possible.

Gold Sentiment

According to Mark Hulbert, the newsletters that write about gold and time this sector are now quite bearish. The Hulbert Gold Newsletter Sentiment Index (HGNSI) is now at -17.2% - meaning that these newsletters are now actually recommending their clients short the market.

While the all time record for pessimism comes in at -31.3%, this measure of gold sentiment has been lower than the current reading only 2% of the time in the past 20 years.

Since gold is clearly in a secular bull market, such a quick retreat after a ~20% drop shows that there is a complete lack of stubbornness on the part of the gold bulls. Which from a contrarian measure is very promising for the continuation of the gold bull market.

So when you have breadth, bullish percent (an alternative measure of breadth) and sentiment all congruently pointing one way, you have a pretty good chance for a profitable trade.