Gold: All Systems Go, Ready For Lift Off

by: Taylor Dart

- Despite the rout in gold prices, the metal is still showing a positive year-to-date return.

- Sentiment on gold is coming off of its most pessimistic level in over 30 years.

- A battle between bulls and bears should take place at $1,200/oz.

The price of gold (NYSEARCA:GLD) has plunged from its 52-week high at $1,378/oz, shaking the bulls out of the metal. Being long gold has become the most hated trade in the market and bears have been cheering. I've applauded the bears several times for their tenacity by staying short gold but couldn't entertain their calls for sub-$1,000/oz. Just as everyone was looking for $1,500/oz and $2,000/oz in August, most are now looking for sub-$1,000, and even $760/oz.
When everyone is in consensus on the direction of a market, I do not want to be on that side of the trade. This pervasive bearishness on gold is evidenced by sentiment, which touched its lowest reading in two years after the Fed meeting. Fortunately, for gold bugs, the despondent readings for gold sentiment have set up a launch pad, at least based on my system. The gold bears are biting off more than they can chew staying short here and could be in trouble going forward.
A couple weeks ago, I noted that we were in unprecedented territory, with the bullish sentiment on gold staying beneath 20% for 22 consecutive trading days. This beat the previous record in 2014 of 21 trading days, and was one of the most contrarian signals I have ever seen. Fast forward 11 trading days and we are still beneath 20% bulls. This is unheard of for any asset class, and I have never seen sentiment this pessimistic in any of the 20 futures markets I follow.
During the Global Financial Crisis of 2008, the 21-day moving average for sentiment touched a reading of 12% bulls. This came on the back of a 33% decline in the market in less than five weeks. The 21-day moving average for gold sentiment just recorded a reading of 9.5% bulls and is the lowest reading I have seen on any asset class before.
(Source: Daily Sentiment Index, Author's Table)
The above table shows the previous record for bullish sentiment staying below 20% bulls and the new record on the left. As we can see, we have exceeded the previous record by 11 days as of yesterday's close. This unprecedented bearishness in the metal has set up a launch pad for my sentiment system. Due to sentiment data staying so low for so long, all of the sentiment moving averages have begun to converge at a reading of 10% bulls. Setups like these are extremely powerful and have the ability to support strong moves without the asset class getting overbought. Due to this being such a rare signal, the most recent example I can think of is the S&P 500 (NYSEARCA:SPY) in February of this year.
  (Source: Daily Sentiment Index, Author's Chart)
The S&P 500 saw all of its moving averages converge near the 10% level in mid-January and this led to an explosive move higher. The S&P 500 gained over 20% from its February lows to its August highs, with only one real dip along the way. I have shown an image of sentiment data above to show a precedent for similar signals. This signal is nowhere near as coiled as the current signal but is the closest example I have from recent data.
  (Source: Daily Sentiment Index, Author's Table)
In the above table, I have shown what the current sentiment data looks like and what's happening underneath the surface. While sentiment on gold was extremely depressed in November, it was below its moving average. This was a large red flag for me as I don't believe depressed sentiment alone is enough to be a buy signal. Instead, I want to see sentiment reach depressed levels and then tick up above its sentiment moving averages.
December has seen a sea change for the metal as gold has closed on three similar instances above its sentiment moving averages. This occurred on December 13th, December 19th, and December 23rd. I have only chosen the first day that sentiment closed above its moving averages after falling back beneath it, as this represents a new buy signal. Between November and January of last year, gold recorded two sentiment buy signals. These signals allowed investors to get long the metal under $1,080/oz. As I have explained in previous articles, my Sentiment Trend system I have built is not a perfect timing indicator. Sentiment is a leading indicator, which means it warns of bottoms and tops before the price is done moving. This allows investors to position themselves in favorable risk/reward scenarios but is rarely perfect at timing the reversal. As we can see from the readings in gold last year (below chart), the first signal took two months to play out. The first buy signal was given in mid-November and gold did not begin its move until early January. Having said that, while the system did not time the move perfectly, it did catch the bottom.
Gold is currently in bull mode and above its sentiment moving averages. It recorded three buy signals in the past three weeks. This is telling us to be prepared for a reversal off the lows, and is giving us an opportunity to position long the metal. I have shown the three recent buy signals with circles in the below chart. There are no guarantees that this sentiment buy signal will play out like the last one. All one can do is put themselves in the market when the edge is in their favor and hope that the signal plays out.
This is the same as in poker. There is no guarantee that one will win money by playing Texas Hold'em at the casino. But the odds are much better that a poker player will be profitable over the long run, if they play only the best starting hands. The gamblers that play the weakest starting hands like 10-5 off-suit, or Jack-6 off-suit will likely lose money over time. The poker players that put the odds in their favor and play suited connectors and high pocket pairs should make money over time. This is exactly how my Sentiment Trend system works, as well as my trend following system. I have no idea which trades will be winners and which losers but if I only enter the market when I have a positive edge, I should be profitable in the long run.
Ok, back to the launch pad I was talking about... It's time to unveil the current sentiment chart for gold. Below is a sentiment chart that I have built. It shows bullish sentiment on gold in relation to its sentiment moving averages. All of the circles are buy signals in the past year, and the two at the left side of the chart are the ones that setup the early 2016 bull market. We can see that a buy signal came in early October but unfortunately, this did not mark the bottom.
Having said that, it did provide a $90 move in gold in less than one month, from $1,248/oz to $1,338/oz on election night. As we can see from the below sentiment chart, the current setup for the moving averages is coiled like a spring.
This was not present in late 2015, nor was it present in early October. This leads me to believe that this move could be explosive if it does play out. In addition to potentially being an explosive move, it also means that gold sentiment has a long way to go before it gets exuberant. A sentiment moving average sentiment like this could easily support a $120/oz move higher before bullish sentiment reached 80-90%. Due to the below chart being a little unclear with the circles, I have provided another chart below so that readers can have a better look at the difference in this setup, and previous ones.
  (Source: Daily Sentiment Index, Author's Chart)
  (Source: Daily Sentiment Index, Author's Chart)
As we can see from a more zoomed in version, sentiment has made a long tight base in the current example, and was much less clean of a base in the 2015 example. This leads me to believe that this should be as powerful of a breakout as early 2016, if not more powerful.
So how am I positioning myself?
Those who have been following me know that I went long gold two weeks ago at $1,176/oz with a stop on my trade at $1,120/oz. This was a half position, and I stated that I would be doubling my position if gold could close above its 200-day moving average. By doubling my position, I would be averaging up on my trade, as gold's 200-day moving average currently sits at $1,275/oz.
The recent strength in the price of gold is encouraging and there is a possibility that we can close above 20% bulls as of today's close. This would be the first close in over 30 trading days above that level, and it would likely set the groundwork for a bottom to be in place. Having said that, I expect there to be a battle at $1,200/oz. The $1,200/oz level was support throughout most of 2016 and the bulls will need to get through this level to open up the possibility for the bull case. Currently, all we are seeing in gold is a dead-cat bounce and a close above $1,200/oz would certainly be constructive for the metal. Ultimately, I want to see gold get above $1,200/oz, in addition to its 200-day moving average. This would prompt me to double my position in the metal and instill confidence in me that we can see a move back to $1,400/oz or higher in 2017.
In addition to being long a half position in gold, I am currently at my largest net long position since February. In my most recent articles, I have shown my most recent purchases long gold, and they are all up an average of 20% or more from my entries the past two weeks. Last week, I unveiled my new positions in Osisko Mining (OTC:OBNNF) and Guyana Goldfields (OTCPK:GUYFF) in my recent articles, and both are up over 20% since. Despite the strong move in the mining stocks this week, I am remaining long my positions, and holding out for higher prices. I want to see what happens at $1,200/oz, an area where I expect there to be some brawling between bulls and bears.
With the strong move in the Gold Miners Index (NYSEARCA:GDX) today, the mining stocks have made decent progress. The index exploded through minor resistance at $20.45 with a gap up this morning. The next level of resistance comes in at $22.50, with six-month support and the downtrend line converge. This is not going to be an easy task for the bulls but we should see a violent short squeeze if this level is taken out. If we can get through $22.50, it is clear sailing until the 200-day moving average (yellow line) at $24.76. This is the last line in the sand for the bears and the only hope they will have to put a stop to a new bull market in the miners.

I remain bullish on gold here, and believe that today's move is a step in the right direction. Having said that, $1,200/oz is the real test, and a level I will be watching if this rally continues.
As long as gold remains above $1,120/oz on a closing basis, I will stay long gold, and I have a stop on my miners at the lows of this rally. This leaves me in a position to risk almost nothing on my miner trades, as I bought the majority of my positions within 3% of the lows the past two weeks. The bears have had a feeding frenzy the past few months but I believe they should be taking very careful at these levels. The risk/reward is no longer in their favor, and sentiment has set up an unprecedented launch pad to move higher from if this move does play out.
(Source: CIBC Investors Edge Account)
  (Source: TD WebBroker Account)
For full transparency, I have shown my main two investment accounts above so that readers can see my money is where my mouth is.

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