New Divergences Emerge

Following the recent break lower in gold, a few small signs of life have emerged. They're only tentative so far and given that the seasonally weak period for gold is  underway, they may not represent sufficient evidence that a low is close – note though that in recent years, significant lows have regularly been made in the May-July period. It makes therefore sense to remain on alert.

Trading volume in gold has been especially heavy one day after the initial break lower – click to enlarge.

Gold remains mired in a downtrend, but gold stocks have begun to diverge positively late last week (i.e., the HUI-gold ratio has turned up after declining sharply in recent weeks). It isn't a very big divergence, but it is the first positive divergence in quite some time. There was probably some short covering, but it may also show that at least some investors are willing to take a punt on gold stocks. Many gold and silver mining stocks have become extraordinarily cheap, both relative to their previous highs and relative to the metals.

The HUI-gold ratio finally perks up a little – click to enlarge.

What is also noteworthy is that there was extremely heavy trading volume in ETFs like GDXJ and GDX and that since June 2013, two divergences between gold and silver have emerged. Such divergences between the two precious metals occurred at the 2011 peaks as well, and also at the lows in 1999-2000. The charts below illustrate the situation:

Heavy trading volume in GDXJ, and divergences between gold and silver prices over the past 11 months. - click to enlarge.

Sentiment and Positioning

On Friday, the DSI (daily sentiment index) of futures traders in gold fell to 10. There have been even lower levels recorded last year – if memory serves, the low was at 5 or 6, but this is definitely a sign that the market is becoming short term oversold. Meanwhile, the sentiment indicators that have medium to long term significance show that negative sentiment remains quite pronounced, but there also continue to be divergences in evidence.

Small speculators in gold futures currently hold a more or less neutral net position, which remains close to the range seen 13 to 14 years ago. Large speculators are still significantly more optimistic, although they have piled into short positions on occasion of last week's breakdown as well.

Commitments of traders in gold futures – small speculators have been very pessimistic since mid 2013, while prices have moved in a sideways trading range – click to enlarge.

The percentage Rydex precious metals assets represent of all Rydex assets combined has fallen to a multi-year low of just above 4% – which compares to a high point of slightly over 35% recorded in 2010. Even at the depths of the 2008 crash this percentage was approximately 3 times higher.

Rydex precious metals assets as a percentage of all Rydex assets are at a multi-year low – click to enlarge.

GTU's discount to net asset value meanwhile continues to shrink. On Friday, with gold down more than $10 at the intra-day low, GTU was actually trading up – in fact, it recorded a positive close.  

As a result, its discount to NAV has declined to 3.4%, which is one of the lower readings seen in recent months. Per experience, a shrinking GTU discount in the face of price weakness in the metal (GTU is a closed-end fund holding gold bullion) tends to be a positive sign. The caveat to this is that the signal has recently 'failed', as it began to show up shortly before the recent breakdown as well. So we are not sure at this stage how meaningful it is, but the fact remains that the fund's discount was lately persistently lower then previously. Moreover, the past record of the signal is actually quite good.

GTU's discount to NAV has shrunk again instead of entering a new expansion trend – click to enlarge.

Conclusion:

Although the metals remain technically weak and the likelihood that gold will eventually retest its lows of last year remains fairly elevated, there continue to be signs that a medium to long term bottoming process is underway. In many ways it remains a mirror image of the drawn-out topping process of 2011-2012. It seems highly likely that there will once again be a tradable low in the May-July time frame this year, which could well turn out to be the low. Moreover, although cheap stocks can and often do get even cheaper, the mining stocks offer  exceptional potential leverage by now – provided the gold price cooperates.

Charts by: stockcharts, sentimentrader, decisionpoint