TUESDAY, APRIL 12, 2011
Is a Near-Term Pullback in Store for Gold?
By MARK HULBERT
If past investment sentiment is any judge, gold bullion could fall back to a more attractive price.
It's understandable why so many gold bulls are feeling rather excited these days.
After all, gold bullion, which was trading Monday in London at $1,476 an ounce, is pushing into one new all-time high after another, and it's an entirely human reaction to become increasingly enthusiastic as the market rises.
Nevertheless, their enthusiasm is a warning sign that the yellow metal is vulnerable to at least a short-term pullback, according to contrarian analysis. As contrarians are fond of saying, the market likes to climb a wall of worry -- and right now it is hard to find much worry in the gold market.
Consider the Hulbert Gold Newsletter Sentiment Index, or HGNSI, which measures the average recommended gold market exposure among a subset of the shortest-term gold timers tracked by the Hulbert Financial Digest.
It currently stands at 67%, which means that the average gold timer is recommending that his clients allocate two-thirds of their gold-oriented portfolios to gold and gold-related investments.
Ominously, every other time in recent years in which gold bullishness rose as high as it is currently, bullion soon suffered a significant correction:
* In March 2008, when the HGNSI rose to 65.4%. That was the first month in which bullion rose above the psychologically important $1,000-an-ounce barrier, and enthusiasm was running high. By early May, gold was trading around $850 per ounce, or $150 less.
* In July 2008, a month in which bullion got close to once again eclipsing the $1,000-an-ounce barrier, though ultimately falling a few dollars short. The HGNSI that month rose to 64.3%. By mid-August, gold was trading below $790 an ounce, two hundred dollars less than where it was just one month earlier.
* In late November/early December 2009, bullion rose to the $1,200-an-ounce level, leading to another burst of excitement among the gold timers. The HGNSI rose to 68%. Within two months, bullion was trading near the $1,050 area, $150 per ounce less.
To be sure, these are just three data points and, compelling as they are, they amount to little more than just anecdotal evidence that gold bullishness is currently at dangerously high levels.
But it turns out that a more comprehensive analysis of gold sentiment reaches the same conclusion. Consider an econometric study of the HGNSI daily readings back to 1985, more than 25 years ago. It found that high HGNSI readings are far more often than not followed by below-average returns for gold bullion, and vice versa -- and that this pattern is statistically significant at the 95% confidence level that statisticians often use to determine whether a pattern is genuine.
This econometric study also contained a silver lining for those gold bulls who are reluctant to give up their hope of much higher prices, however: The HGNSI has its greatest forecasting power over the short term, and this short term is shrinking. So the HGNSI's current lofty level tells us nothing about where gold will be trading in, say, a year or two -- or even at the end of this year.
Up until the last five years, for example, the HGNSI's greatest explanatory power existed at the three-month horizon. It also had some explanatory power over a one-month period, and none over a two-week horizon. Over the last five years, in contrast, the two-week period has become the one where the HGNSI has the greatest explanatory power.
What this means: Gold may indeed be headed to the $2,000-an-ounce level and beyond by the end of this year -- predictions we are hearing with increasing frequency as bullishness in the gold pits becomes increasingly widespread. But if contrarian analysis is correct, then you should be able to buy gold in the coming weeks more cheaply than where it is trading now.
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