Got Gold Report - Mining Shares Signal Strength
By Gene Arensberg
04 Sep 2006 at 12:11 PM
HOUSTON (ResourceInvestor.com) -- An interesting and infrequent technical conflict between the graph signatures for gold metal and indexes for mining shares is currently underway, the resolution of which has important implications for resource investors regardless if they are long or short. The battle pits a well-defined ascending triangle formation for mining shares against a tightening triangle consolidation inside a larger potential consolidation triangle for gold metal, close enough to a descending triangle to assume its characteristics and resolution potential.
In plain words, there’s an argument between gold and mining shares and it is about to be resolved one way or another. On Friday, the last trading day before a three day holiday weekend and traditionally regarded as one of the lightest liquidity days of the year, bulls perhaps had the upper hand in the battle as mining shares were challenging resistance while gold meandered inside the confines of its triangle having reconfirmed $607 support earlier in the week.
Most feel that mining shares react to the price of gold and other precious metals as opposed to the opposite. Indeed over time that statement holds water pretty well. As the price of gold marches higher, generally speaking mining shares do too and vice versa. However, from time to time the leadership of the two can change. In other words, from time to time the shares get out ahead of gold in either direction for a while.
Mining shares were boosted for the week by word of another blockbuster merger announcement (Goldcorp/Glamis) as well as resilience and strength put in by silver, which looked late week to be breaking out of a month-long tight sideways consolidation of its own. More about silver below.
That is not to say that the miners had an unfair advantage or that the indexes were artificially higher, to the contrary. There must be some underlying reason (or a basket of reasons) that mining shares have been outperforming the metal since the middle of July.
As of this past week, part of the strength of mining shares may have more to do with silver than with gold. Sometimes silver leads the way.
In any event, the battle of the gold descending (looking) triangle and mining share’s ascending triangle sure looked interesting, like it was about to resolve as the week came to a close.
As the resource sector conference season prepares to get underway in Las Vegas this week (Hard Assets Investment Conference September 6-7), battle lines are drawn and the game is on. Thanks to the internet each of us has a ringside seat to follow the gold market versus mining shares action.
Moving into this week’s indicators:
COT Changes. Tuesday 8/29 commitments of traders report (COT). The large commercials (LCs) collective combined net short positions (LCNS) dropped sharply by 10,828 or 8.5% to 117,245 contracts net short Tuesday to Tuesday while gold metal dipped $9.60 or 1.5% to $614.15. Gold on the cash market tested as low as $607.79 on 8/29 finding support about where it did on the 18th ($607.40). Since Tuesday gold clawed back up $10.94 to $1.74 above where last week left off, showing a last, pre-holiday weekend trade of $625.09 Friday.
Total COMEX gold open interest edged higher 1,412 lots to 307,583 open contracts.
Long-term, June ‘07 and beyond COMEX forwards added 462 lots to 62,940 or a still very high 20.3% of open contracts, not quite keeping pace with the open interest increase.
As for the LCNS: As of this reporting period Tuesday, over the past four weeks, three reporting weeks, while gold metal fell $29.74 or 4.6% from $643.89 to $614.15, the collective combined net short positions of the large commercials declined by 24,680 or 17.4% from 141,925 to 117,245 contracts net short. That’s not quite a 4:1 ratio, still below a four-week pace that historically signals a rush to close net short positions, but improved and considerably better than last week’s look at this indicator. To illustrate the increase of velocity of LCNS reduction as gold dipped to $607 and change the one-week percentage ratio was 5.7:1.
The rate of change for the week accelerated to 1,128 net short contracts closed or offset per dollar reduction in the metal, good enough to raise the four-week pace to 830 net short contracts gone per dollar reduction in the metal.
Tuesday’s LCNS is roughly equivalent to its lowest point in June, (6/27, 116,241) immediately following gold’s harsh correction (6/14) to as low as $542.27. For the record, cash market gold closed 6/27 at $582.13. So as of Tuesday, with gold at $614 and change, the LCNS was just about as low as it was immediately following the June nadir for the metal.
Keep this indicator on the bullish side of the gold market ledger. Had the rate of change been considerably less than it was, or had the LCNS remained flat or rose as gold declined, that would have switched the indicator to bearish.
LCNS-Gold Graph as of Tuesday:
Gold ETF. For the week gold holdings at streetTRACKS Gold Shares, the largest gold exchange traded fund [NYSE:GLD], edged a little higher 1.55 tonnes to 392.07 tonnes of gold bars held by a custodian in London for the trust. Very similar to the previous week, as gold moved lower there was at least enough buying demand to cause a small addition to the GLD gold holdings.
As mentioned last week, given the light summer liquidity just about any dip buying strong enough to affect liquidity of GLD sufficient to cause another gold addition keeps this indicator onto the bullish side of the ledger. A larger addition and more than one for the week would have been more compelling. Had there been any reduction at all on declining gold it would have changed the ETF indicator to bearish.
Financial data for GLD updated daily at streetTRACKS Gold Trust.
Silver ETF. As noted in this RI piece from August 31, positive money flow continued for Barclay’s iShares Silver Trust [AMEX:SLV] during the month of August. Demand for the shares resulted in the addition of 247.35 tonnes of silver for the month. What is remarkable about that is that until just the last trading day of the month silver metal moved sideways in a tight $1 range. As September got underway silver was taking a shot at a breakout of that tight trading range.
There are 23 trading days in the eighth month of the year. That means that SLV added new silver at the rate of 10.75 tonnes per trading day while the metal consolidated sideways. Evidently there was considerable appetite for the highly liquid silver metal investment vehicle, with continued accumulation, even though the metal went mostly nowhere.
For comparison, SLV added 294.32 tonnes of silver in July, 434.2 tonnes in June. July saw one significant dip mid-month and June saw the depth of the harsh correction following the May peak for the metal. There was no similar dip for the metal in August in other words. Rather than dip buying, August’s demand for SLV appears to be anticipatory investment buying.
SLV metal holdings graph: (Note: The graph begins at May 10 following the initial ramp up of holdings after the April 2006 inception.)
Gold Charts. As reflected in the daily chart gold spent the first two days of the week retesting the $607 region and just like two weeks ago that’s where support kicked in. Then right back up to the 50-dma. Please also see the 2-year weekly version for context.
Readers might want to compare the daily charts of gold and the HUI for a ringside view of the coming battle. Both are in tightening triangles, but with completely different signatures.
With gold still more or less clinging to its 50-dma inside a tightening triangular consolidation this indicator remains neutral for the week.
U.S. Dollar. The LCs lightened up by 754 contracts to 4,687 NYBOT contracts net long while the USD index continued to trade sideways, down 19 basis points to 84.97 Tuesday to Tuesday. Whether that reduction in their long exposure reveals a weakening of long confidence or just pre-holiday weekend squaring, the LCs remained firmly on the long side. Since Tuesday the greenback went nowhere, down just 3 ticks closing Friday at 84.94.
Last week’s U.S. Dollar section said: “If the buck is going lower as most of the financial talking heads continue to say, why aren’t the largest of the largest currency traders net short? So far the USD is still confounding very vocal dollar bears, much to the relief of other global currencies and economies.”
Please see the 1-year daily USD chart and the 2-year weekly USD version for additional commentary.
With the LCs still holding most of their net long positions, indicating their short-term belief that the dollar will firm up, right or wrong this indicator remains on the bearish side of the gold market ledger.
Gold Indexes. All over the globe technically minded portfolio and fund managers, long and short-term traders and investors large and small track their favorite indexes and make trading decisions based on them. The AMEX Gold Bugs index, [AMEX:^HUI] which follows a basket of fifteen of the most popular mining companies that generally do not use hedging and therefore should have more leverage to the gold market, is one of the most popular of those indexes and is the index that this report tends to focus on weekly.
At the week came to a close, the HUI was attempting a breach above resistance in a mature ascending triangle, which shows on the 6-month daily HUI chart.
Repeating last week’s rather long, but timely commentary: “As the trading tightens inside an ascending triangle formation, sell stops for the various component companies tend to ratchet up underneath and following the rising lows as short-term traders and speculators seek to protect profits. At the same time buy stops (including short trailing stops) tend to congregate in an even tighter bunch just above the obvious horizontal resistance. This strongly suggests that if the trading moves convincingly out of the triangle confines there should be considerable fuel to support the move in the direction of the break or breakout.
For long-term context, here is the daily HUI from April 2004 to date. Lest anyone think that this condition is peculiar to the HUI, it is not. Here are the 2-year weekly XAU and the 3-year weekly GOX for comparison.
A word of caution is in order here. Indexes are a usually weighted compilation of multiple individual stocks and indexes can and often do send short term false signals for a variety of reasons. Professional traders learn over time to assign varying levels of importance to those technical index signals and, except for those traders who have close automatic trailing or buy stops, they generally do not take immediate knee-jerk action unless the signal is obvious and convincing or unless a less-than-clear signal is confirmed.
As one example, a modest break in either direction might have a majority of technical traders on guard, watching it closely for signs of confirmation rather than just “taking it” and trading it immediately at face value. As another example, in order to eliminate some or most false signals, some professional traders have trading disciplines they follow religiously which provide that a break must hold for a period of time, measured in days, or cover a certain percentage before the signal is accepted. For these and other reasons any less-than-obvious index break or breakout of a well-defined technical formation can take some time, also measured in days, to develop. It is sometimes not at all like a switch being thrown in other words, but for short-term traders a break or breakout most certainly should not be ignored.
Having said that, once a break or breakout does become convincing, trading stops in either direction get tightened for the components of the index and the indicated move usually becomes self-fulfilling to a degree, all else being equal.
There is another event to watch for and that is the possibility of a failed technical signal. Failed technical signals are strong indicators themselves, in the opposite direction and there are traders that specialize in trading them. When an obvious technical break or breakout of a well-defined technical formation reverses course, negating the technical signal, the market is speaking loudly and we need to pay attention to it. We will undoubtedly have more about this subject in future reports.
Summing up the thought for short-term traders, ignore compelling, well-developed technical index formations at your peril, but we should keep in mind that breaks or breakouts need to be convincing for a majority of technically minded fund and portfolio managers to take decisive action.”
Given the HUI’s attempted breakout, this indicator moves to bullish.
HUI:Gold Ratio. The popular HUI:Gold Ratio measures the relative performance of mining shares versus gold. When the ratio is rising mining shares are putting in a stronger performance relative to the metal and vice versa.
If anyone wanted confirmation that mining shares outperformed gold metal for the week, then look at the one-year daily HUI/Gold ratio chart. As pointed out last week, “the miners have been modestly outperforming since the middle of July, as expected. Please see the July 21 comments on the 2-year weekly HUI/Gold version for that expectation.”
For whatever reason, mining shares continued their out performance relative to gold, keeping this indicator on the bullish side of the gold market ledger this week. It is this week’s most bullish indicator.
Spot Gold-HUI. The spot gold minus HUI indicator improved yet again by another 6.59 points, from 278.46 to 271.87, confirming that mining shares outdid gold metal, probably reflecting the action in silver more than anything.
Short-Term Outlook: (Long-term bullish, short-term breakout watch, extreme caution for bears, significant dips, if any, should be bought.)
The gold market by itself (apart from silver or mining shares) still seems to be looking for a catalyst. As of this writing the question of what the catalyst will ultimately be has not yet been answered. The tension on the catapult just got a little tighter this week.
The HUI and other mining share indexes have set up for a potentially large percentage move as a 3-month ascending triangle moves toward resolution. By the end of the week the HUI was challenging its triangle resistance.
Mining shares often telegraph movement in the metal in advance. For example, they regularly bottom before the metal does on retreats and the miners usually meet collective resistance in advance of the metal on bull runs up. If mining share indexes are sending any short-term signal at all today it is that gold is going higher.
If the current modest breakout attempt for the miners takes hold and becomes convincing, gold will almost certainly follow – probably with gusto. There is an opposite side to that statement in the event that the miners are beaten back and exit the ascending triangle to the downside. That would require a reversal of momentum at this point, but either case is, of course, possible, depending upon what the ultimate catalyst ends up being to move the market decisively.
As mentioned above, if, and only if the current HUI resistance challenge becomes convincing, there ought to be considerable fuel to support the move in that direction, especially given the large short positions currently on the popular miners.
Bulls will no doubt be comforted by the current HUI challenge of resistance (as well as the miners uncanny out performance since mid-July).
Bears, on the other hand, will likely point to this week’s move as a light liquidity anomaly, which will, in their view, more than likely be corrected as soon as the “Big Boys” return from vacation, back to their respective trading desks in the coming week. They would say that, but nonetheless tighten their trading stops “just in case!” To bears: Light liquidity and AWOL traders might explain some of this past week’s action, but it doesn’t answer the strength of the miners since the middle of July.
Short-term traders for mining shares have the luxury of being able to adopt “near resistance” trailing stops, tighter than normal, but well below very tight “at resistance” levels. This stance allows for normal volatility but protects significant profits in the event of a failed breakout and harsh counter reversal. Short term traders for gold metal and the ETFs probably already have adopted the same stop levels.
As gold moved lower earlier in the week, the LCs reduction of net short positions accelerated. The LCNS was almost as low Tuesday with gold at $614.10 as it was in June just following gold’s plunge to $542.27. That’s short-term bullish and strongly supports the notion of a rising floor for gold often suggested here. Indeed a strong case could be made at this point that bargain hunting and dip buying would pick up the pace not all that far below where the current technical gold triangle would theoretically break down. Based on that, sustained support would probably form above the current 200-day moving average, which is crossing $587.29.
With the fifth anniversary of 9/11 looming and national elections in the U.S. now just two months away, there is also the obvious underlying very real potential for another exogenous shock from the radical Mohammedanism cultists. If for no other reason than that, bears ought to either wait for chart resolutions or at the very least employ the tightest of protective stops.
Bottom line. As of this instant the odds favor firmer gold prices over the short term, with the potential for a large percentage move still possible in either direction depending on the catalyst that ultimately moves the market. Should the short-term signals prove false and gold metal breaks out of its triangle lower, it is this report’s opinion that significant dips for gold should be bought in measured bites and strong dips bought aggressively.
High to extreme volatility and wide ranging days remain very possible short-term.
With that said, as always MIND YOUR STOPS.
Long-Term Outlook: No change. A secular bullish perfect storm trend for precious metals continues. Rapidly escalating global investor demand, easier participation by investors via ETFs, conversion of Middle East petroleum dollars to gold, rising new demand from Asia, possible central bank buying partially offsetting central bank selling, conversion from dollars to gold by large U.S. dollar denominated foreign exchange reserves, declining gold production, increased political and NGO interference to bring new sources on line, rapidly escalating costs to produce, delays and shortages of equipment and manpower, previous two-decade bear-market-induced shortage of intellectual capital for miners, safe-haven buying to hedge strong, reckless, competitive dilution of under-backed fiat paper currencies and continued troubling global political and religious tensions are just some of the factors contributing to the bullish winds now blowing. In real terms gold remains undervalued versus nearly all other commodities and strongly undervalued as measured by the world’s fiat paper promises. … The Great Gold Bull has a long way to go. It just won’t go straight up.
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 streetTRACKS Gold Shares and iShares Silver Trust, and holds various long positions in mining and exploration companies.
© Copyright 2006, Resource Investor.
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