GLD Gets Shot Out Of A Cannon

by: SomaBull



- There have been powerful rallies in GLD over the last few years, which all ended up fading and fresh new lows were ultimately hit.

- The second the HUI surpassed that 135 level, it was time to buy aggressively.

- It certainly seems that we are now finally seeing a major change in the trend, one that has been in place for 4-5 years now.

- Should gold price continue to increase over the coming months, this would keep the door open for further 25 basis point moves by the Fed.

- If it looks like a duck, walks like a duck, and quacks like a duck, then it's probably a duck.

 
What an incredible three weeks it has been for the SPDR Gold Trust ETF (NYSEARCA:GLD), as gold has all of the sudden come bursting back to life after a tumultuous 4-5 year bear market. In mid-January, this sector looked like it was on the verge of taking one final plunge, but it then turned around on a dime and has exploded higher.
 
There have been powerful rallies in GLD over the last few years, which all ended up fading and fresh new lows were ultimately hit. However, this rally has been extremely violent, more so than any of the previous bear market bounces that have occurred since 2012 - both in terms of duration and gain. At one point last week, GLD was up 20% since the start of the year. We did have a 20% increase in GLD during 2013, but it took about 2 months to complete and occurred just after gold took a 30% plunge. This time around, GLD was coming off of a 10% decline and has proceeded to tack on an enormous percent increase in a very short amount of time. In other words, we really haven't seen a rally like this one. Which is why the sudden chatter that the bear market in gold could be over.
 
There is no question that GLD is way overbought in the short term, and today we are starting to get a much needed correction. Whether this is a new bull market or not simply can't be answered until we see higher highs, as we never got that true washout event in gold that would have definitively marked an ultimate low (not that we really needed one in the first place).
 
However, either way, this sector should have been bought in January and then bought aggressively on the breakout of the NYSE Arca Gold BUGS Index (HUI).
The Downtrend In Gold Stocks Has Been Taken Out
 
For the last year or so, I have been talking about the well-established overhead resistance in the HUI. Early last month, in an article I wrote called, "Gold: It's Time To Prepare For A Bottom," I posted the chart below. What I saw was a clear signal that the bear market was going to be over within a matter of a few weeks to a few months, as the HUI needed to pick a direction since all of this was converging (basically, the bear market was running out of room on the chart). Down and it would get that final washout, up and it would break that red resistance line. At the time, I stated that if the HUI did take out that downtrend line: "the bears need to start thinking about finding a good hibernation spot for the next several years."
 
Source: StockCharts.com
 
 
I was leaning towards the HUI moving lower, and it started to go that direction as the month of January progressed. Towards the end of that month, my call was that gold stocks were looking like they were about to take that final decline, as both the HUI and XAU had in fact broken down, with the XAU in particular taking a waterfall plunge. But the drop abruptly ended (a clear bear trap in hindsight), and below is what has occurred since then. It's been a very powerful rally that took out the massive overhead resistance. The second the HUI surpassed that 135 level, it was time to buy aggressively.
 
Source: StockCharts.com
 
 
But investors should have been buying this sector before then, as I mentioned in my January 7 article (as well as in the follow-up article a week later), that I was changing my strategy for how best to play this bottoming process. Instead of waiting for a final plunge, it was time to be selective and start accumulating gold and silver stocks on any weakness. While it would have been nice if all precious metal shares were moving lower in tandem, what was transpiring was totally different. Instead of a cohesive move to the downside across the entire sector, you had a few gold stocks breaking out to the upside, you had some that were just treading water or moving slightly higher, and you had others breaking down very hard. It was imperative to modify the strategy for how to play this, as it was becoming clear that the bottom in the gold sector was going to require a little bit more cherry picking, and the timing wasn't going to be as cut and dry as I was expecting before.
 
I felt at that moment it was best to take off the bear hat and watch how it all unfolded, and as I said: "it's time to start putting cash to work and preparing for not just "the turn," but for the eventual rebound in the sector." That wasn't a go all-in call, that was simply too risky until we saw a breakout. But it was time to buy.
 
The good news is this strategy has worked out very well (at least so far), as we saw a continued deterioration in many names as the month of January progressed. There were some major bargains as a result. For instance, I mentioned I had my eye on Coeur (NYSE:CDE) and that any bout of weakness in the sector could create a further drop in the name, which would be a buying opportunity.
 
It was $2.38 at the time (January 7), and it proceeded to decline to just under $1.70 later in the month. It then swiftly rebounded, and it surged 18% on Friday alone, closing at $3.33. If you were picking up bargains here and there during January, and then bought the breakout of the HUI aggressively in early February, you would be doing very well right now. Even with today's decline.

The question is where do we go from here in the short term? There are plenty of investors still on the sidelines who would love to know that answer. I could see many scenarios unfold, but I'm leaning towards a decline back down to 140 or so in the HUI. I wouldn't be surprised either if we just have small corrections and today's losses are quickly made up in the next several days. We simply might not get that big of a correction until the HUI hits 200. It's tough to tell at this point. In a bull market, sometimes just a brief pullback is all that occurs, which is enough to bring down the overbought technical indicators such as the RSI.
 
I would never count out the possibility of all of this reversing again and moving lower, especially in an extremely volatile sector like gold, but we have a lot of positives right now. To me, this all looks good, especially since the HUI broke out of that major downtrend (which I have been watching and waiting for since early 2015), and this fits the timetable that I had in mind in terms of this bear market wrapping up. Should the HUI decline back down under the 125-130 level, then it would be time to re-evaluate.
 
General Equities Deteriorate Further, Causing Investors To Rush To Gold
 
A rising stock market has been enemy #1 for the gold sector, that's always been the case going all the way back to the 1970s. It wasn't until we saw general equities roll over that gold would take off. The S&P has clearly been in a topping pattern for many months now, but hadn't fully given up yet. Three weeks ago, I thought there was a possibility that it could have one final rebound back up to 2,000 or so - in what would be a last desperate attempt by the bulls to sucker people into believing that this train wasn't going to stop. If that occurred, the S&P would be a prime short candidate at that juncture. That last gasp attempt would also allow the gold sector to have that final decline. But general equities weren't able to find their footing, and instead experienced further weakness after having already been very oversold.

What started to become clear over the last month was that the smart money was beginning to flow out of the stock market and into the most beaten down sector in the world right now: precious metals. I believe that it's logical to conclude that the reason why gold stocks weren't all bottoming at the same time is because this sector rotation was starting to take place. New (and big money) buyers were entering gold and putting firm bids under some of these precious metal stocks.
 
When that final attempt for a rebound in the S&P never materialized last month, the flood gates were opened. Now we are starting to see a mass exodus out of general equities and into the precious metal sector. This is just the start of the rotation.
 
I will say that we had a similar event in early 2015 as well, as it looked like we were finally seeing this much anticipated rotation out of equities and into gold. But it never developed completely, as investors rushed back into the stock market a few months later and gold sold off.
 
However, this move is much more powerful, and the circumstances aren't the same. In January 2015, the HUI had increased by about 30% from its December 2014 lows. The index is up by about 60% from the lows from last month. There was a 10% gain in GLD during January 2015, compared with a 20% gain this time around. The S&P was also still in an uptrend in January 2015, today that uptrend has clearly been broken and the index looks very sickly. You also have rising interest rates here in the U.S., and it's no coincidence that gold appears to have bottomed in December 2015 along with the fed funds rate.
 
It certainly seems that we are now finally seeing a major change in the trend, one that has been in place for 4-5 years now. We still need further confirmation though.
 
Negative Interest Rates
 
In December 2015, and in the Fall of that year as well, it seemed as if nobody believed that the Fed was going to raise rates at that final meeting. Now, given what's occurring in the stock market, few believe that the Fed will raise rates at any point in 2016, and we have talk of the possibility of negative interest rates hitting the shores of the U.S.

We already have countries moving to negative interest rate policies, all without disrupting the financial fabric of their markets or causing severe upheavals in both the functioning and efficiency of global financial systems. The U.S., though, is going in the opposite direction, as the 25 basis point increase in December 2015 puts us on a contradictory path.
 
(Source: NY Times)
 
 
With Fed Chair Yellen now stating that the Fed has discussed negative interest rates, the thinking goes that the Fed is about to reverse course and not only take back that 25 basis point increase, but is also considering moving rates into negative territory. Investors are jumping the gun here, just like they did in September when the Fed held off raising rates.
 
Yellen admits that the Fed has never fully researched the idea of NIRP, and she is also saying that there are no rate cuts planned at this point. But the very fact that it was mentioned seemed to make many investors foam at the mouth at the possibility that the Fed was about to embark down this path.
 
I was almost 100% certain of a rate hike last December, and I still believe that further increases in the fed funds rate is a likely possibility as well. Which puts me firmly in the camp that we aren't about to experience a Negative Interest Rate Policy here in the U.S., at least not any time soon and not unless we see some major declines in asset classes. That includes gold as well.
 
While everybody is still worried about deflation and feels that is what is coming down the pipe for the U.S., gold's latest move higher could actually be signaling that it's inflationary pressures that are finally building. Ironic because nobody is expecting that at this juncture, but when something is least expected, that's usually when it occurs.

I have never been worried about deflation and I'm not worried now, which is why I never believed that gold would fall too much further if it had one more decline in store. We will have to see if this is the correct call or not, but I'm still firmly in the inflationary camp.
 
Should gold continue to increase over the coming months, then this keeps the door open for further 25 basis point moves by the Fed, irrespective of what the stock market is doing.
 
Although, I will say that the likelihood has grown that the next bump up in rates will be pushed back to the April meeting instead of occurring in March.
 
I'm simply not buying into that huge deflationary outcome that many are predicting, as I believe we are on the precipice of the opposite occurring. Any further increase in gold will help back that argument up.
 
Long-term interest rates are moving lower, which seems at odds with this call. But considering gold isn't moving down with treasury yields at this juncture, and the precious metal sector has staged a breakout, then at the moment I'm going to side with gold. Which means that a reversal in treasury yields is to be expected over the coming year.
 
Long-Term Outlook For Gold And The Sector
 
The long-term fundamentals for gold look exceptional, and it's only a matter of time before the old highs of $1,900 will be taken out, most likely within the next 2 years. Last month I stated that I thought gold could reach $1,200-$1,400 at some point in 2016, I certainly didn't expect it to hit that level a few weeks later, as the short-term outlook still was very dicey and gold appeared that it wanted to head lower not higher.
 
Given the recent surge, it seems that even the upper end of that price target range might be too conservative. It's quite possible that we will see gold hit $1,500 before the year is over. But honestly, I'm not too concerned if it doesn't reach that level in 2016; I would be content to just see some stability and some well deserved gains in the sector.
 
Yes, some stocks have in fact doubled over the last month, while other big names are up 50% or more. But when you look at this on a 5-year chart, the gains so far look like a blip considering where these stocks were at just a few years ago. Which shows you the potential percent moves that still lie ahead for this sector. That should be of some consolation to those still on the sidelines. We have a long way to go here, if you pick the right stocks, you could easily be talking 300-500% increases over the next 2-3 years (from current levels), and that is being conservative.
Click to enlarge
Source: StockCharts.com
As for what I'm doing at this moment, well, I was buying in January and then bought the breakout heavily. I still have some cash and was waiting for a pullback first, which we appear to be getting. I'm still keeping an eye on that 125-130 level in the HUI, just for precautionary measures.
The ending for this bear market was clearly in sight last month, and that would still be the case even if this all reverses. It seems like a long-term bottom has been reached, but we still don't know with 100% certainty. We do know that gold stocks have broken out, we know that gold itself is taking out many key levels, and we have never seen a 60% increase in the HUI during this bear market. If it looks like a duck, walks like a duck, and quacks like a duck, then it's probably a duck.

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