Just over six weeks ago, we had calls for $2,000/oz gold (GLD (NYSE:GLD)) from several different analysts, and it’s always disconcerting for an asset class when this occurs. Just as I would be anxious if analysts started trotting out target prices for the S&P 500 (SPY (NYSE:SPY)) at 4000 tomorrow, I warned that things were getting a little frothy for gold. While we’re only a few percent off of those highs currently for the metal, the drop in the gold juniors (VanEck Vectors Junior Gold Miners (NYSE:GDXJ)) has been a completely different story. Many names have plunged 25% from their highs, and the Gold Juniors Index has seen a 16% correction from peak to trough. Fortunately, this has helped to wash away some of the bullish sentiment in the sector, with sentiment now down nearly 70 basis points from its August highs. Rather than get frustrated, investors should welcome more fear seeping into the industry with open arms.
As I shared a little over six weeks ago, we got a sentiment sell signal on gold in late August. The metal’s 16-week moving average headed into the exuberance zone, as displayed on the below chart. This push into the exuberance zone was the fifth one in just over ten years, and a minimum of 5% corrections followed all prior moves into this zone. One of these pushes into the exuberance zone led to the long-term top in August 2011. Fortunately, for investors, this was only the first test in several years, which suggests that it’s unlikely to play out similar to how the August 2011 top did. However, it still presented an opportunity for investors to be tactical and start booking some profits. Six weeks later, this long-term sentiment moving average has dropped back out of the exuberance zone, and some bulls have shifted from enamor for the metal, to utter disgust. This is an excellent sign and is a massive step in the right direction for carving out a bottom in gold.
Looking at the updated chart of bullish sentiment for gold above, we can see that the 16-week moving average has now dropped down towards the 70% level. This is well out of the danger zone where we sat in August. In addition, the raw readings of bullish sentiment have plunged from 95% in August to 32% as of Friday’s close, a drop of nearly 70 basis points. As I have shown at the bottom of the above chart, the three corrections from similar sell signals bottomed out at readings of 33% bulls, 13% bulls, and 46% bulls, before resuming their uptrends. If we average out these three readings, we have a median drop to 33% bulls before the metal bottomed, and an average reading of 31% bulls. Based on the current reading of 32% bulls, this suggests that we have satisfied the bare minimum required for us to entertain the possibility of a bottom showing up soon.
It is important to note that these are averages, and this is a sample size of three. Therefore, we cannot comfortably say that we must bottom this moment because we have in the past. However, it does give us some context for where we currently sit with relation to past sell signals. If things were to get worse, we could head to 13% bulls like the Q4 2010 correction, which lasted seven weeks, and corrected 9.0%. In a best-case scenario, we are in the process of bottoming currently. If we assume the worst case and this plays out like Q4 2010, gold would correct down to $1,424/oz from its $1,565/oz high, and then make new highs within six months. A drop of this magnitude would have no trouble getting us similar bullish sentiment levels in the low double-digit range and would be a buy with both hands opportunity. If this is it for the correction, it might be time to start entertaining the idea of adding new exposure soon.
While I have done some nibbling on a couple of gold miners, I have not started a long position in the metal just yet. I believe that any further weakness below $1,460/oz would be an opportunity to begin scaling into the metal, as this would likely drop sentiment into the pessimism zone we’re looking for. Currently, we’re sitting just above it at the 32% level. It should be music to investors’ ears that we’ve gone from euphoria to anxiety in the gold market in a little over a month, yet no real technical damage has been done. If investors do panic over the next few weeks, this should be an opportunity to take advantage of their panic and start stocking up on the highest quality miners.
Disclosure: The author owns shares of Franco Nevada Gold (FNV) and Marathon Gold (CA:MOZ)
The SPDR Gold Shares (NYSE:GLD) (GLD) was trading at $139.68 per share on Tuesday morning, down $0.91 (-0.65%). Year-to-date, GLD has gained 12.96%, versus a 12.50% rise in the benchmark S&P 500 index during the same period.
GLD (NYSE:GLD) currently has an ETF Daily News SMART Grade of B (Buy), and is ranked #1 of 33 ETFs in the Precious Metals ETFs category.