- Bullish sentiment for gold finished at 95% Monday, and the sentiment moving average is at a level it’s reached only three other times in the past decade.
- While these sentiment readings led to higher prices over the next six to twelve months in two of three occasions, they led to a long-term top in the other.
- I believe this is a prudent time for investors to take some profits on their gold positions, while holding the majority of their position for a bigger move.
While I was early in calling a short-term top on gold (GLD) last week, the point I made was that upside above $1,480/oz was likely on borrowed time. This analysis is based on the fact that bullish sentiment is now at its highest levels in nearly eight years, and investors are rarely rewarded short-term when everyone has piled into a trade. The way that sentiment works, however, is that it is a leading indicator. This means that it pin-points short-term tops well ahead of them occurring, vs. a laggard indicator which tells you after the fact “by the way, you probably should have taken some profits a week ago.” I much prefer leading indicators as they give me time to adjust and monitor a market as it heads into levels of either extreme pessimism or extreme exuberance. So if we saw exuberance last week, then we must be seeing mania this week, right? Let’s look at the catalysts for this gold move first.
While Powell’s switch from a hawkish to dovish stance initially lit the match for a gold rally, the recent cut in June has poured fuel on the fire. Powell attempted to talk down the potential for a Fed rate-cutting cycle, but the fact is that he has little choice in the matter with inflation indicators collapsing. The 10-year yield sits at 1.7% currently, down from 2.1% just two months ago, and Core Producer Price Index (PPI) turned negative last month for the first time in over two years. If the Fed is looking to support the market as it has in the past, it has every excuse to provide a boon to a slowing growth story with further cuts. While many people may believe it’s irresponsible to cut in the current scenario, the Fed has no choice but to cut further. The Fed is much more worried about deflation than inflation, and the collapse in inflation indicators in Q2 and further into Q3 has given them lots of room to do so. Fortunately, for gold bugs, this is music to their ears. Rate-cuts are great for gold as they prompt a return to inflation, and the fact that we likely have a minimum of two more rate-cuts on the table emboldens the bull thesis.
So what is the problem then, and why would we even consider taking profits? The issue is the sentiment, and short-term it’s getting very over-heated.
Looking at the below chart of Daily Sentiment Index Data, we can see that the red sentiment moving average is now hovering above 80% bulls, an alarmingly high level. This suggests that four out of every five market participants are bullish over the past twelve weeks. This has only happened three other times in the past decade, and two of those occurrences are shown below. I have chosen not to include the October 2011 signal as I do not believe it to be similar to the current environment technically. However, it would strengthen my current thesis of a pullback if I had chosen to, as we dropped 40% from those levels and put in a long-term top.
Looking at the April 28th, 2011 sell signal below, bullish sentiment was also hovering near 90%, and the sentiment moving average (red line) crossed the 80% threshold, a short-term sell signal. We can see the same thing in the June 11th, 2010 sell signal, with the sentiment moving average crossing the 80% threshold in early June.
So what happened after these occurrences? I’d be remiss if I didn’t provide charts to show this. Looking at the April 2011 sell signal, the market dropped 7.5% over the next two weeks, and then went sideways for six weeks before heading to new highs.
In the June 2010 sell signal, the market traded 2% higher first, and then plunged 9% over the course of three weeks, before making new highs three months later. If this were to play out similarly, the gold market would either top out here or head slightly higher short-term. However, both scenarios point to a drop to $1,450/oz minimum short-term (1-2 months). There is no guarantee that this occurs, but history often rhymes and human nature never changes. When everyone jumps on one side of a trade, it rarely ends well short-term.
Based on this, I believe this rally is providing an opportunity for traders to sell into this current strength at $1,530/oz for a portion of their positions, and look to buy back that position at $1,420/oz to $1,460/oz. At the minimum, I would expect a 5% correction if we got 7% and 9% corrections in the past two occasions. While this likely seems like the opposite of what one should do right now, this is how the market typically works. When the times comes to sell, you never actually want to. Common sense and what feels comfortable rarely pays in the market, but I believe that the pendulum has swung too far to the bull camp short-term that a 5% correction is imminent. While I am open to a rally 2% higher before this tops out like the June 2010 sell signal, ultimately, I think we are heading back under $1,470/oz before the end of Q3.
The SPDR Gold Shares (GLD) was trading at $141.62 per share on Tuesday morning, down $1.01 (-0.71%). Year-to-date, GLD has gained 14.53%, versus a 10.07% rise in the benchmark S&P 500 index during the same period.
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About the Author: Taylor Dart
Taylor Dart has over 10 years of experience in active & passive investing specializing in mid-cap growth stocks, as well as the precious metals sector. He has been writing on Seeking Alpha for four years, and managing his own portfolios since 2008. His main focus is on growth stocks outperforming the market and their peers. In addition to looking at the fundamentals, he uses different timing models for industry groups, and scans upwards of 2000 stocks daily to identify the best fundamental opportunities with the timeliest technical setups. Taylor is a huge proponent of Trend Following and the “Turtles” who enjoyed compound annual growth rates of over 50 percent per year..