Written by Jim Welsh
Gold and Gold Stock Update: 30 March2016
In my last update on gold and gold stocks entitled, “The Coming Correction In Gold and Gold Stocks” on Sunday March 6, I discussed why I thought gold and gold stocks were likely to experience a correction in coming months. On March 7, gold traded in a range of $1260 to $1274.90 before closing at $1265.10. The gold stock ETF GDX traded in a range of $19.92 to $20.73 before closing at $20.40.
In the following weeks, gold traded down to $1206 on March 28, and is trading at $1229 as this is being written. GDX fell to $19.02 on March 23, and is currently trading at $20.09.
The obvious question is whether the recent decline comprises all of the expected correction, or is there more to come? I think there is more to come.
According to the Commitment of Traders report as of March 22, the trend following ‘dumb’ money is more long gold than it was last October, just before gold dropped from $1,180 to under $1,080 in less than five weeks. Large speculators (green line middle panel) were long +178,831 contracts in the March 22 report compared to being long +157,434 contracts last October, and managed money (blue line bottom panel) is long +144,899 compared to +116,344 contracts in October. This indicates that those who use trend following strategies have become quite bullish gold, which from a contrary opinion perspective is bearish.
More importantly, the ‘smart’ money is short more contracts than they were last October, and even increased their short position since the March 1 report. Commercial speculators (commercial specs, red line middle panel) are now short -199,999 contracts vs. -165,848 in October. Producers have increased their shorts from -102,946 in October to -130,267 as of March 22.
Gold rallied from $1046.20 to $1287.80, a gain of $241.60. If it retraces 61.8% of the rally, gold would fall to $1138.50, and to $1097.90, if it retraces 78.6%. Gold is beginning to form a potential head and shoulders top, with the low at $1206 representing the neckline. Should gold close below $1206, it would target a decline to $1124.40.
Given the positioning of the smart money, a decline to under $1140 seems quite likely and would represent a decline of 7.2% from current levels. If gold does decline by 7.2% in coming months, gold stocks are likely to fall 2 to 3 times as much.
The gold stock ETF GDX rallied from $12.40 to $21.42, a gain of $9.02. A 50% retracement of the rally would target $16.91. GDX also appears to be forming a head and shoulders top, with the neckline at $18.86. If GDX closes below $18.86, a decline to $16.30 could occur. There is a large gap at $15.35 that could be filled if GDX retraces 67% of its rally.
As I said in the March 6 Update:
“In other words, gold and gold stocks may endure a correction of the recent large rally, with gold falling back to $1,160 – 1,180, and GDP dropping below $17.00. The coming correction will shake out the weak hands that jumped on the band wagon in the last few weeks.”
The odds of this correction occurring have increased. For those who want to take advantage of this correction, I would recommend a 10% in the inverse gold ETF DGZ, which is NOT leveraged. I would use a close in gold above $1274.00 and a close below $14.00 on DGZ as a stop. DGZ is currently trading at $14.54. I would sell 50% of the position in DGZ if it trades above $15.45.
