Got Gold Report - Gold Near a Bottom?

By Gene Arensberg
11 Aug 2008 at 04:09 PM GMT-04:00

The report looks at the gold market and lists factors which suggest that a bottom might be near.

ATLANTA (ResourceInvestor.com) -- This summer has been a tough one for those who follow and invest in the very risky, but also the very promising small junior and micro-cap mining producers, wannabe producers and explorers. Looking at the CDNX, the closest index to the small resource sector, it is reminiscent of 2002's harsh sell down. Only this time the decline is much worse and makes much less sense given where gold and silver are currently trading.

The graph below charts the performance of the CDNX versus gold metal monthly since 2001. When the ratio is rising, small mining stocks are outperforming gold metal and vice versa. When compared to gold, the last year for the CDNX has been the harshest since the Great Gold Bull began in 2001. It doesn’t take a technical expert to see that the small miners have been, … well, killed over the past year as evidenced by the chart.

The Got Gold Report (GGR) is still on summer hiatus (through August) but unusual developments in precious metals prompted this special report.

Blood in the Streets

We are in about the same position as the big plunge in the CDNX in 2002 for just about all the comparison metrics except that both gold and silver are multiples of where they were then. So, what we are witnessing right now is much, much worse than the 2002 retreat in the index’ relationship to gold metal. That’s what makes the ghastly conditions in the small resource companies today so dang maddening. It just doesn't make any sense to those who expected the small resource companies to leverage the price gains for the metals. Calling small resource companies cheap right now is like calling the universe big. Both are gross understatements.

Anyone can rattle off a long list of reasons for the illogical price action, investor fear, the Credit Crunch, flight to cash, etc., but what it boils down to is a vacuum of liquidity in the small resource sector. Hardly anyone is buying and every day someone quite literally HAS to sell. Today, often that means selling into weak or nonexistent bids, driving the small guys into or under the basement.

Investor confidence in small resource companies (and for that matter virtually all highly speculative issues) has been shattered. Holders of those stocks are demoralized and reeling from portfolio shock if they have held on at all. Very few of the funds which had been buying these unbelievable high-percentage-on-tiny-volume dips are still doing so, and now rumors are swirling that more than one large Canadian or Bahamian hedge fund, funds that were heavily invested in the small miners have blown up and have been (or are being) liquidated, putting intense downward pressure on shares of the companies those funds held. (The rumors are likely true.)

Small resource companies, even the tiny ones that trade on Canadian bourses, have also come under attack from ruthless game-playing short selling sharks attracted by so much obvious lack-of-liquidity and buyer’s strike opportunity. For some time now these miscreants, as Dr. Patrick Byrnes dubs them, have run roughshod over all but a very few companies which have had the good fortune of short seller-discouraging (and sometimes unexpected) good news.

Analysts, newsletter writing stock gurus and financial commentators focused on the resource sector have developed a kind of bunker mentality as many of them prepare for the upcoming resource conference season, which unofficially kicks off (no pun intended) in September. “I’ve (just) about turned off my computer,” says one popular newsletter writing colleague who considered skipping the Denver Gold Group’s high-profile invitation-only forum set to begin Sunday, September 7, in Denver. “It’s a can’t miss event and too many of the companies I am (invested) in will be there, or I would just stay in my bunker,” he added.

The beginning of conference season usually marks the end of the weakest period of the annual cycle for mining shares, but because of crummy conditions, this season holds very little in the way of last year’s hopeful enthusiasm as we head into the jaws of August.

We could continue on with this morose line of thinking and analysis and so far we’ve only just touched on the very dire and exceedingly uncomfortable conditions we have at present, but that’s not the point of this special Got Gold Report. What is the point?

Well, we’ve all heard the adage “buy when there is blood in the streets.” How about another one, “buy when you are ready to puke!” Friends, there IS blood in the streets in the small resource sector right now, in August of 2008. Buckets, gallons, and oceans of blood in the streets of Toronto and New York.

Seasoned veteran stock traders who thought the bottom was already in and committed resources to their small miner faves in the early part of this year have already had their heads handed to them twice over. By now they are dry heaving, many probably from the sidelines. Some of the promising small resource companies have been beaten back to below where they began this Great Gold Bull, even lower than they traded in 2002. Does that make sense with both gold and silver trading where they are? (It’s a rhetorical question.)

In short, (again no pun intended), even the most contrarian of contrarians has to be wondering at this point whether or not the Great Gold Bull is indeed over as so many talking heads on televised financial media have regurgitated in past weeks. Even the most diehard gold and silver perma-bull is probably secretly second guessing his or her positioning in precious metals about now. Finally, even the most ardent newsletter writing champions of small resource companies are probably entertaining, for the first time since 2001, a change in their focus, or even their line of work!

Has the Great Gold Bull taken a matador’s sword through the shoulders? Is it really “Game Over” for the small resources sector? This report thinks not and continues to believe the best is yet to come for both the metals and for mining shares.

That could be wrong-headed, but just about everything this report follows suggests the gold and silver bull markets are just undergoing a significant pause in their historic, once in a generation run to dazzling heights. And, if the signals this report follows closely are correct, this correction anomaly may have already gone too far.

For example, in no particular order, consider the following observations about gold, silver and mining shares:

1. HUI discounting gold in the $500s. Can you say “oversold?” On Friday, August 8, the HUI index closed at 334 and change, after plunging a huge 14.4% in one calendar week and 30.3% in just the last trading month. That suggests a wholesale fearful exodus out of mining stocks. The HUI first passed through 334 on the way up in late January of 2006 when gold was trading in the $560s. Are mining stocks then currently discounting gold to fall back into the $500s? Really? (See graph at this link.)

2. Not much gold selling by GLD. Despite the obvious exodus of liquidity out of mining shares over the past week, interestingly there was actually not that big a reduction in the amount of gold held by the largest gold exchange traded fund, SPDR Gold Shares [GLD]. While gold metal continued its harsh sell-down to the tune of -$53.34 or a teeth gnashing -5.9%, the gold ETF reported a reduction in metal holdings of just 14.99 tonnes and still holds 659.03 tonnes of yellow gold bars (worth $18.06 billion) through its custodian in London. If there really was a wholesale exodus out of gold metal underway, shouldn’t there be much larger reductions in the trading float and in metal holdings at the largest ETF proxy for gold metal?

3. COMEX open interest plunges. Using data on COT reporting Tuesdays, the total open interest on the COMEX peaked most recently on July 15 at 483,920 open contracts. As of Tuesday, August 5, the COMEX total open interest showed 408,430 contracts open, a reduction in total open interest of 75,490 contracts. By Friday, August 8, the total open interest had fallen even more, down to 376,797 contracts open.

When was the last time that there were so few open gold contracts at the COMEX? Last September 11, 2007 when there were 373,686 gold contracts open and gold traded at $712.05. (Incidentally, the total open interest reached its nadir last year on August 28 at 325,767 contracts open.)

4. COMEX commercial net short positioning lower, but not (yet) as low as expected. On July 15, the COT reports showed traders classed by the Commodities Futures Trading Commission (CFTC) as “commercial” held collective net short positions covering 246,577 contracts out of a total open interest of 483,920 contracts open. That meant their net short positions represented 50.95% of all the open contracts. By Tuesday, August 5, they had reduced their net short positioning by 47,660 or 19.3% to show 198,917 contracts net short. Gold had moved lower $102.96 the ounce or 10.5% from $977.31 to $874.35 for the period.

Despite what is seemingly a large reduction in the net short position of the large commercial traders (LCNS) some analysts had actually been expecting more in the way of LCNS reduction because gold closed Tuesday, August 5 (COT reporting cutoff day) at $874.35, so much lower than the previous Tuesday (29 July, $918.83). However, gold had traded mostly sideways to up in most of the COT trading week prior to August 5, and only really got going to the downside that Monday, August 4.

Since gold closed very near its lows for the COT trading week on Tuesday, there really hadn’t been much incentive for commercials to cover their net short positions when the cutoff had arrived.

Remember from number 3 above that the total open interest has since fallen considerably, so there is a very good chance that the expected much larger reduction in LCNS will begin to show in the next COT report to be released this coming Friday, covering the period through Tuesday, August 12. If that’s true, then we ought to also see the LCNS percentage to total open contracts fall quite a bit as it did in August of last year.

As the chart above graphically illustrates, up to August 5, although the number of net short contracts held by commercial traders had declined considerably, it was still a high percentage of the total open. As the chart also demonstrates, a drop in LCNS percent to total is NOT a prerequisite to a significant advance in gold metal. A large drop in the LCNS percent to total open does tend to lend additional confidence for long trades, however, and vice versa.

For those who prefer to look just at the nominal amount of LCNS, please see the graph below. (Please note that these two graphs cover different time periods.) Importantly, last year one of the largest drops in the LCNS occurred in the COT report just AFTER the lows were put in for gold metal (the week of August 21, 2007).

Should we see a significant reduction in the LCNS in this coming COT report? In a word, yes, even if gold should recover strongly by COT reporting cutoff day Tuesday. If we do not see a significant reduction in commercial net short positioning in the next COT report it would be more bearish than bullish.

6. Gold is fast approaching its 60-week moving average. Finally, as New Orleans based Gold Newsletter’s Brien Lundin pointed out in emailed comments to subscribers over the weekend, gold is fast approaching its 60-week moving average. (Lundin uses a similar 300-day moving average.) Since the Great Gold Bull began in 2001 and established a new uptrend in 2002, the yellow metal has approached its 60-week moving average less than a dozen times. Each time it has come near the 60-wma that has turned out to be a profitable time to add or buy gold. (Please see chart.)

Currently, the 60-wma crosses at about $832, but using an exact number for such things is much too narrow for targeting at this scale. Anything within $25 either side of that magic line should be considered a challenge of it. So Friday’s $857.57 close is pretty darn close to a challenge of the 60-wma. If history counts for anything, we are very close to a technical zone where we should expect gold to find overwhelming and very determined support.

Buy Cheap and Sell Dear

The trading for small resource companies over the past year has become a kind of killing fields, but smart, tough-minded and well respected individuals in the industry remain undaunted. Some have begun to speak out publicly about the irrational price action in the sector.

For example, in an August 6 news release Rob McEwen, Chairman and CEO of US Gold [UXG], President and CEO of Lexam Explorations [LEX.V] and former chairman and CEO of Goldcorp [GG] had comforting words for beleaguered and beaten up shareholders as well as a call to action for investors who may be fearfully sitting on the sidelines.

"We are in a market where the share prices of junior exploration companies are in a free fall. I am confident this trend will reverse and when it does I believe the move to the upside will be rapid. The key factors for higher prices will be increasing merger and acquisition activity led by well financed producers, higher precious metals prices and a big discovery. Once investors believe they can make money buying junior explorers, such as US Gold, the share prices should start moving higher. I believe this summer represents a great buying opportunity," McEwen said.

Another well worn adage in the financial markets is to buy cheap and sell dear. In order to accomplish the latter one has to first attempt to accomplish the former. Is it time now, or is there yet another horrible mother-of-all plunges to go before “The Turn?” We’ll see, got gold? Got spec mining shares?

Got Gold Report Charts

Silver Graphs. Please see the 1-year silver graph and the 2-year weekly version for this report’s technical and expanded market commentary on the graphs themselves.

Gold Charts. Please see the 1-year daily chart for gold and the 2-year weekly version for context as well as this report’s technical and market commentary on the charts themselves.

Gold Indexes. Please see the 9-month daily HUI chart and the 3-year weekly HUI chart for context and this report’s commentary on the graphs themselves.

HUI:Gold Ratio. Please see the one-year daily HUI/Gold ratio chart and the 2-year weekly HUI/Gold version for context and this report’s commentary on the graphs themselves.

U.S. Dollar. Please see the 1-year daily USD chart and the 2-year weekly USD version for this report’s technical and market commentary on the charts themselves.

That’s it for this special offering of the Got Gold Report. Until next time, as always, MIND YOUR STOPS.

The above contains opinion and commentary of the author. Each person should study the issues carefully and, as always, make their own informed decisions. Disclosure: The author currently holds a long position in iShares Silver Trust and holds various long positions in mining and exploration companies.