Hulbert on Markets
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FRIDAY, JUNE 8, 2012
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Gold Can Finally Redeem Itself
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By MARK HULBERT
Though bullion has disappointed many in recent months, the contrarian sentiment indicators bode well for the metal.
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Take heart, gold traders!
Though bullion's behavior over the last couple of months has been frustrating at best, it's worth remembering that the precious metal is still modestly higher than where it stood at the beginning of the year. That's even the case in the wake of gold's plunge on Thursday after Fed chairman Ben Bernanke said that the Fed would not immediately implement a third round of quantitative easing, or QE3.
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It's also worth remembering that the dejection that currently grips the gold market is a good sign from a contrarian point of view.
Yes, yes, I know—contrarian analysis has been bullish on gold at least since mid-March, and so far gold has failed to respond. After having frustrated gold traders for nearly three months, why should contrarian analysis suddenly prove to be on target now?
My answer: Gold's recent weakness in the face of favorable sentiment conditions is extremely rare -- so rare as to be the exception that proves the rule. In fact, there has been only one other time over the last three decades when bullion performed as poorly in the wake of bullish-sentiment conditions. And it soon thereafter rebounded smartly.
Consider the average recommended gold-market exposure among a subset of short-term gold timers tracked by my Hulbert Financial Digest (as measured by the Hulbert Gold Newsletter Sentiment Index, or HGNSI).
Let's turn the clock back to mid-March, which is when contrarian analysis turned bullish on gold.
That bullish turn was prompted by an extraordinary exodus of gold timers away from the bullish to the bearish camp. Over the 14 trading sessions from late February until March 19, during which time gold fell by around $140 an ounce, most of the previously bullish gold timers I monitor threw in the towel.
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The HGNSI plunged from 51% to -16%, with this negative level indicating that the average short-term gold timer was now advising his clients to allocate a sixth of their gold-oriented portfolios to going short.
In my three decades of tracking gold-market sentiment, I hardly ever had witnessed a 67-percentage-point drop in average exposure level in just 14 trading sessions. That is what led contrarian analysis to conclude that the sentiment winds had shifted to begin blowing in the direction of higher-gold prices.
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The anticipated gold rally never materialized, however. To the contrary, from March 19 until the end of May, bullion dropped another $120 per ounce, or 7%. The PHLX Gold/Silver index, a group of precious-metal mining stocks, fell even further, dropping more than 12% over the same period.
To determine how unprecedented and unexpected gold's behavior was, I scoured the historical record for any other instance in which bullion dropped as much in the wake of similarly bullish-sentiment conditions. I came up with just one since mid-1985, which is when the HFD began measuring gold-market sentiment.
That historical parallel dates to the last couple of months of 1997 and first trading sessions of 1998. After frustrating contrarians over that three-month period in which sentiment conditions were favorable, gold proceeded to turn in very handsome gains -- 7% over the subsequent month and a full 10% over the subsequent quarter. The XAU's corresponding gains were even more spectacular -- 15% over the next month and 30% over the subsequent quarter.
To be sure, gold's experience in 1998 provides just one data point. So if that were the only basis for contrarians' current confidence, you'd have every reason to be skeptical.
So as a reality check, I submitted all three decades' worth of daily HGNSI readings to rigorous econometric testing. Those tests confirmed that, at the 95% confidence level that statisticians often use to determine if a pattern is genuine, lower-HGNSI readings tend to be followed by higher-gold returns than in the wake of high-HGNSI levels—just as contrarians have contended over the years.
The bottom line? There has been only one other time over the last three decades in which gold, in the face of favorable sentiment conditions, frustrated contrarians for as long as it has over the last couple of months. And gold rebounded sharply following that prior occasion.
Contrarians even more confidently than before now believe that gold is poised for a significant rally.
Though bullion's behavior over the last couple of months has been frustrating at best, it's worth remembering that the precious metal is still modestly higher than where it stood at the beginning of the year. That's even the case in the wake of gold's plunge on Thursday after Fed chairman Ben Bernanke said that the Fed would not immediately implement a third round of quantitative easing, or QE3.
.
It's also worth remembering that the dejection that currently grips the gold market is a good sign from a contrarian point of view.
Yes, yes, I know—contrarian analysis has been bullish on gold at least since mid-March, and so far gold has failed to respond. After having frustrated gold traders for nearly three months, why should contrarian analysis suddenly prove to be on target now?
My answer: Gold's recent weakness in the face of favorable sentiment conditions is extremely rare -- so rare as to be the exception that proves the rule. In fact, there has been only one other time over the last three decades when bullion performed as poorly in the wake of bullish-sentiment conditions. And it soon thereafter rebounded smartly.
Consider the average recommended gold-market exposure among a subset of short-term gold timers tracked by my Hulbert Financial Digest (as measured by the Hulbert Gold Newsletter Sentiment Index, or HGNSI).
Let's turn the clock back to mid-March, which is when contrarian analysis turned bullish on gold.
That bullish turn was prompted by an extraordinary exodus of gold timers away from the bullish to the bearish camp. Over the 14 trading sessions from late February until March 19, during which time gold fell by around $140 an ounce, most of the previously bullish gold timers I monitor threw in the towel.
.
The HGNSI plunged from 51% to -16%, with this negative level indicating that the average short-term gold timer was now advising his clients to allocate a sixth of their gold-oriented portfolios to going short.
In my three decades of tracking gold-market sentiment, I hardly ever had witnessed a 67-percentage-point drop in average exposure level in just 14 trading sessions. That is what led contrarian analysis to conclude that the sentiment winds had shifted to begin blowing in the direction of higher-gold prices.
.
The anticipated gold rally never materialized, however. To the contrary, from March 19 until the end of May, bullion dropped another $120 per ounce, or 7%. The PHLX Gold/Silver index, a group of precious-metal mining stocks, fell even further, dropping more than 12% over the same period.
To determine how unprecedented and unexpected gold's behavior was, I scoured the historical record for any other instance in which bullion dropped as much in the wake of similarly bullish-sentiment conditions. I came up with just one since mid-1985, which is when the HFD began measuring gold-market sentiment.
That historical parallel dates to the last couple of months of 1997 and first trading sessions of 1998. After frustrating contrarians over that three-month period in which sentiment conditions were favorable, gold proceeded to turn in very handsome gains -- 7% over the subsequent month and a full 10% over the subsequent quarter. The XAU's corresponding gains were even more spectacular -- 15% over the next month and 30% over the subsequent quarter.
To be sure, gold's experience in 1998 provides just one data point. So if that were the only basis for contrarians' current confidence, you'd have every reason to be skeptical.
So as a reality check, I submitted all three decades' worth of daily HGNSI readings to rigorous econometric testing. Those tests confirmed that, at the 95% confidence level that statisticians often use to determine if a pattern is genuine, lower-HGNSI readings tend to be followed by higher-gold returns than in the wake of high-HGNSI levels—just as contrarians have contended over the years.
The bottom line? There has been only one other time over the last three decades in which gold, in the face of favorable sentiment conditions, frustrated contrarians for as long as it has over the last couple of months. And gold rebounded sharply following that prior occasion.
Contrarians even more confidently than before now believe that gold is poised for a significant rally.
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