Bullish Gold Technicals

Gold has been weathering some considerable selling pressure lately, which has naturally turned sentiment quite pessimistic. Bearish commentary abounds, with all kinds of predictions for further declines. But as is usually the case after any material selloff spooks traders, gold's technicals are actually very bullish today. Gold's next move will likely prove to be a major rally.

Gold's latest selloff started on February 29th when the Fed Chairman's testimony before Congress convinced traders that a third round of quantitative easing is becoming less likely. Gold plummeted 5.1% on this latest in a long line of irrational QE3 scares, its biggest down day since the stock panic. Over the 6 weeks since, gold has retreated as much as 9.3% at worst (including that initial plunge).

Of course gold's day-to-day price action has felt weak during this selloff, sparking plenty of fears, anxiety, and worries in the hearts of speculators and investors. But as always in the markets, the tyranny of the present deludes traders into foolishly missing the forest for the trees. Perspective is crucial to maintain, as keeping current events properly framed within longer-term context short circuits the perilous emotions of greed and fear.

This essential context is easily obtained with charts. While the past several days' gold action dominates psychology, odds are it isn't even relevant over a longer time horizon. For my own trading, I generally use 6 months or so to keep my own emotions in check. I don't worry about any daily selloffs (or get excited about any daily rallies) until a move persists for long enough to actually be material on a 6-month chart.

And though I'm looking back several years in this essay to illustrate gold's bullish technicals today, the principle remains the same. Gold has been beaten down to very favorable buying levels within the context of its post-panic bull-market uptrend. Traders who can overcome their fears and fight the worried crowd to buy gold and gold stocks at these cheap levels will almost certainly be richly rewarded.

This first chart looks at gold's technicals superimposed over a powerful sentiment indicator I call Relative Gold. Based on my simple and very profitable Relativity trading system, it considers gold as a multiple of its own 200-day moving average. Over time this rGold metric (gold's close divided by its 200dma) forms a horizontal trading range. When rGold slumps to low oversold levels, it is a fantastic time to buy cheap.

Let's start with basic gold technicals, which are easy to understand. Bull markets trend higher, usually in uptrend channels. These are defined by the lows and highs carved by the underlying price. When connected with straight best-fit lines, the periodic lows delineate support while the highs show resistance. In any trending market, you want to buy near support. When prices hit this lower boundary of their uptrend channel, they are as cheap as they're likely to get as long as that bull remains alive and well.

In this entire post-panic era, gold has seen many major rallies launch right after these support approaches. Fully 5 of them are noted in this chart, and after all but one gold soon powered to new record highs. And now today, once again gold has just hit this same major support line. Since this key technical buying level has held strong for several years running, there is no reason to expect it to suddenly break down today.

The bears will attack this thesis, arguing that gold's bull is over or at least that the lack of more quantitative easing has severely wounded it. But these arguments don't hold water. Secular bull markets are driven by global supply-and-demand imbalances. And with gold investment demand around the world growing while this metal gets harder and harder to mine, gold's fundamentals remain very bullish. This bull won't give up its ghost until mine supply starts growing faster than investment demand.

On the quantitative-easing front, as I explained in detail last week QE3 or the lack thereof is largely irrelevant. Even without QE3, the Fed has been inflating the underlying US dollar supply like there is no tomorrow. Since QE2 ended, broad MZM money-supply growth has approached 10% annually. And the narrow M0 monetary base has been soaring by 30%! So even without QE3, the Fed is still unleashing unbelievable torrents of fiat-money inflation that will greatly buoy gold prices.

Despite the silly QE3 scares that have hammered gold from time to time, consider what this metal has done since QE2 wrapped up at the end of June 2011. Gold surged an amazing 26% higher in the next 7 weeks on fears Obama's record profligacy would force the first-ever Treasury downgrade or even default in US history. Since QE2 ended, gold has averaged $1693 on close in a high consolidation. Such levels were never even approached in the QE2 days. Make no mistake, gold has thrived in this post-QE era!

Gold's bullish basic technicals today are greatly buttressed by the rGold read, where this metal is trading relative to its baseline 200dma. We define Relativity trading bands based on the latest 5 calendar years of price action. Over this timeframe, gold tended to bounce near 1.05x its 200dma. So whenever the gold price falls to around 5% above its 200dma, the probabilities favor buying for an imminent major rally.

But as you can see above, rGold has recently plunged much farther. The recent selling in gold has been so overdone that it was battered down to just 0.96x its 200dma last week. This is extremely oversold, an anomaly driven by excessive fear which is never sustainable for long. In the past 5 years, gold has only seen similar radically oversold levels twice. The end of last year and during the brutal stock panic.

Back in December, similar irrational fears about the Fed curtailing quantitative easing briefly pounded gold to similar deeply oversold levels. But as usual they weren't sustainable. When a price falls too far too fast, everyone susceptible to being spooked into selling anytime soon is driven out. These weak hands simply can't handle the intense psychological pressure. Their selling climax leaves only buyers remaining, and their new dominance soon ignites a major rally.

Between those late-December lows and late February, gold rocketed 15.5% higher in just 8 weeks! A similar rally today from its recent interim low would carry gold to $1870 by late May. The only other time gold was this oversold was during the stock panic. And throughout the several years since that once-in-a-lifetime fear superstorm, gold has more than doubled. Extremely oversold conditions are incredible buying opportunities!

This next chart looks at the necessary foundation of the bears' thesis that gold's bull is dead, waning investment demand. The best proxy for whether or not investors are increasing their gold holdings is the massive GLD gold ETF. The flowing and ebbing of its enormous holdings document whether the vast pools of stock-market capital are generally flowing into or out of gold. This ETF is a direct conduit between the stock markets and physical gold.

When stock traders buy GLD shares at a faster pace than gold itself is being bought in the futures markets, this ETF risks decoupling to the upside and failing its tracking mission. So its custodians equalize this buying pressure by issuing new GLD shares. They then immediately use the proceeds to buy physical gold bullion to store in their vaults. This mechanism directly shunts stock-market capital into gold.

So if gold investment demand was truly waning, it would absolutely show up in GLD holdings. Yet as this chart reveals, GLD's holdings have not only continued growing since the end of QE2 but they are again nearing a record high. The bears' gold-investment-demand-waning thesis is fabricated, there is no basis in reality for it. They merely assume the lack of a QE3 is somehow going to gut gold investment demand.

After surging soon after the stock panic on massive hedge-fund buying, GLD's holdings started trending higher in a strong post-panic uptrend that persists to this day. Once again the only way this ETF's bullion hoard can grow is if stock investors are deploying more capital into gold via GLD on balance than they are pulling out. And obviously this has continued to happen even in this post-QE2 world.

Back in spring 2010, a major surge in stock-market demand for gold exposure drove GLD's holdings well above trend. They then spent much of the next year drifting back towards trend. But once they hit their uptrend support line, they started surging again. Provocatively, this was right when QE2 was ending! Did the goofy QE-fixated bears fail to tell stock investors that without QE3 there is no reason to own gold?

Despite the record gold prices and high consolidation we've seen in the 9 months since QE2 wrapped up, gold investment demand remains strong. And it should. Every investor, small or great, should have a material fraction of gold in his portfolio. For over a decade now, I've recommended between 5% to 20% of every portfolio should be deployed in gold. It provides critical diversification from stocks, fantastic protection from unforeseen crises, and excellent appreciation potential in its ongoing secular bull.

Even for an aggressive speculator, a bare minimum of 5% of his capital should be in gold bullion. Are stock investors there yet? Not by a long shot! This week GLD's total holdings were worth about $69b. Meanwhile the collective market capitalization of all the elite stocks of the flagship S&P 500 stock index is around $12,866b. So by this measure, stock investors as a group have only 0.5% exposure to gold so far.

Given gold's stellar track record of gains since 2001, beating virtually everything else over that span, I can't imagine any prudent financial planner or investment advisor not recommending at least a 5% allocation into gold. And to merely get to 5% relative to the S&P 500 alone, GLD's holdings would have to soar by an astounding 10x! Yes, an entire order of magnitude. Today's gold bull just isn't mature yet as evidenced by the continuing low levels of investment in this metal.

Gold simply isn't popular enough, there isn't enough mainstream participation and enthusiasm, for its secular bull to burn itself out anytime soon. Just as I was writing back in the early 2000s when it was a ridiculed hardcore contrarian position, I still believe gold has to get popular among average investors before this bull runs its course. The entire world is still radically underinvested in this essential portfolio component.

So this whole lack-of-QE3 fear thing recently plaguing gold makes no sense at all. This metal has already proven it can thrive in this post-QE era, which has still seen monetary inflation by the Fed running at a breakneck pace. And once you can get past this flawed psychology, realize gold has been beaten down to low technical levels from which it has launched plenty of major rallies in recent years.

But the truly great near-term upside potential in this metal is dwarfed by the opportunities in gold stocks. Though gold is cheap, gold stocks have been pummeled to panic levels relative to the metal that drives their profit streams and hence stock prices. Gold stocks have been left for dead, all but abandoned. But their fundamentals remain stronger than ever, and sooner or later they will soar to reflect today's prevailing gold prices. They've recently traded as if gold was near $900, even though it was over $1600!

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The bottom line is gold's technicals are very bullish today despite all the bearish sentiment out there. Irrational lack-of-QE3 fears have driven gold down to its uptrend's support line which has launched major rallies for several years running now. And relative to its baseline 200dma, gold was recently as oversold as it has been since the stock panic. These technicals reveal awesome near-term upside potential.

And contrary to the bears' theses throughout gold's recent selloff, gold's fundamentals remain strong. Investment demand continues to grow even in this post-QE world, while mined supply remains tightly constrained. And despite gold's long and strong secular bull, investors remain heavily under-invested in this critical portfolio component. Odds are a major gold rally is imminent, and may have already begun.