FRIDAY, NOVEMBER 5, 2010
Gold's Golden Wall of Worry
By MARK HULBERT
The reaction of market timers to the metal's recent trading activity suggests that the rally can continue.
THE REACTION BY PRECIOUS metal market timers' to gold's pullback starting in mid October points to a bull market that is very much alive and well.
At no point during gold's correction over the last three weeks was there evidence of the kind of stubborn bullishness that is the hallmark of major market tops. On the contrary, the gold timers in the wake of gold's weakness appeared eager to sell and go to cash.
Furthermore, in the wake of gold's extraordinary rally this week, gold timers have exhibited reluctance to jump back on the bullish bandwagon.
On all counts, there is abundant evidence of an ample foundation of pessimism on which gold's bull market can continue to build. As contrarians are fond of saying, a bull market likes to climb a wall of worry—and there is a very robust wall of worry among gold timers right now.
Consider the average recommended gold-market exposure among a subset of the shortest-term gold market timers tracked by the Hulbert Financial Digest (as measured by the Hulbert Gold Newsletter Sentiment Index, or HGNSI). Its historical range over the last three decades has been from 89.6% on the high side to minus 31.3% on the low side. (That negative number meant that the average gold timer at that time was recommending a short position in gold.)
The HGNSI currently stands at 41.9%, less than half its all-time high. That reflects an amazing amount of cautiousness on the part of the typical gold timer, given that gold's correction from its mid-October high never drove gold down by more than 5%—and given that, in the wake of bullion's stunning mid-week rally, gold is now back to within shouting distance of rising into new all-time high territory near $1,400 per ounce.
A number of other perspectives on sentiment trends also paint a similarly bullish picture.
Consider, for example, how low the HGNSI dropped in late October, in the wake of gold's modest correction: It fell to 30.6%. The last time the HGNSI was that low was this summer, at a time when gold bullion was trading around $1,200 an ounce. In other words, even though gold bullion in late October was more than 10% higher than the previous time the HGNSI was at 30.6%, the average gold timer was nevertheless just as cautious.
That's a very positive contrast.
Another bullish omen: Consider how high the HGNSI reached last December and in January of this year. Early last December, when bullion was trading below $1,200, the HGNSI stood at 68%. In mid January, when bullion dropped to below $1,130, the HGNSI stood at 60.9%.
Those high HGNSI readings indicated that there was a relatively high level of bullishness among the gold timers, which in turn was a bad sign according to contrarian analysis. Sure enough, gold declined—not bottoming out until early February below $1,060 an ounce.
Today, in contrast, with gold bullion trading for as much as 20% more than then, the HGNSI is markedly lower. Once again, this suggests that there is a robust wall of worry for gold's bull market to continue climbing.
Note carefully, however, that contrarian analysis is a short-term trading tool. Even when its analysis is on target, it doesn't tell you whether the market a year or more from now will be higher or lower. Contrarian analysis instead has its greatest forecasting power at the one- to three-month time horizon.
Whether gold's anticipated rise from here will last longer than just a couple of months depends crucially on how sentiment behaves in coming weeks. If, in the wake of any gold strength that materializes, the gold timers quickly and enthusiastically jump on the bullish bandwagon, then contrarians will begin to conclude that the rally is nearing some sort of a top. Their conclusion will be reinforced if, in the wake of any gold weakness that then develops, the gold timers stubbornly cling to their bullishness.
In contrast, contrarians will continue to believe that gold's bull market has further upside potential so long as the gold timers remain—as they are today—quite cautious, if not outright skeptical.
Stay tuned.
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