08/22/05 - TraderMike: Gold/Oil Update
Last Monday I wrote an update on the gold markets and told you that I believed some sort of healthy pullback in gold would happen over the next few weeks, probably from a slightly higher level. Also, I noted that the commercial short position had grown to 150,830 contracts - a sizable level.
Well, according to the latest Commitment of Traders Report, the commercial short position is now huge. As of the close last Tuesday, commercials are now net short 193,366 contracts. This represents 72.2% of their open interest in the gold futures market.
That's a big position and every time they have been this short over the past four years there has been a dip in the metal. At the peak in June, they were net short 143,062 contracts. Gold then fell from a high of 441 in June down to 417 in July, a 24 point drop.
Current support levels on gold are at 434, 430.53, 425, and then 420. The odds are we will see gold dip down to 430.53. There is also a good chance that the metal will briefly fall to 425, from where it would probably quickly reverse back up to 430.
Now, even though I think that gold is likely to pullback over the next few weeks, I don't think it is something you should get overly concerned about. I'll show you why with a chart of the XAU.
Since May, the XAU gold stock index has been soundly outperforming the price of metal, rising quickly when the metal is up and holding up when the metal has pulled back.
Take a look at the action in the XAU during June and July and compare it with gold. Notice what it did when gold pulled back in July. Spend some time on this. Print out this article and take a closer look if you think that will help.
While gold dropped 24 points the XAU barely fell at all, holding above 90 throughout the entire gold pullback. In hindsight this was an incredible display of strength and not surprisingly a breakout above 95 up to 100 took place on huge volume right after the pullback in gold came to an end.
Now, remember how you felt during this time. If you were holding gold stocks, the drop in gold may have scared you a bit. I personally had a large position in gold stocks and ended up selling them one day to prevent losses only to realize that the technical picture was actually improving. I bought them back the very next day.
With gold falling the past few days and the news that there is a huge commercial short position on the metal you might feel timid again just like you may have been in June and July. But just like June and July, after the metal correction is over, the XAU will be blasting off again to new highs. You don't want to get shaken out of your position because of your fears only to see gold stocks go up after you sell.
Study the charts more closely. While the June and July correction was happening, gold would fall to certain support levels, try to hold them, fail and fall lower. It would then repeat this pattern again and again until finally it bottomed at 417 as the commercials closed their short positions. Now look at how the XAU acted during this time. When gold had down days the XAU would also fall, but on days when gold held up, the XAU would strongly bounce. While gold was stair stepping down, the XAU was holding the 90-91 level like a rock.
The XAU outperformed gold during the last gold pullback. It is doing the same thing now and that means any pullback here is likely to have the same characteristics as the last one. Despite a probable drop in gold to 430 or 425, the XAU is likely to hold its support levels - which are now 95 and then 92.33. It will do this by bouncing hard on days when gold is up. And then as soon as gold finishes its correction, the XAU will be making a new high to rally to the 105-110 level.
With gold now only a few points from its 434 support level, it is liable to bounce towards the beginning of this week, helping pop the XAU for a day or two, and then fade down to 430 by the end of next week or early next week to move toward its next bottom.
I receive almost 100 emails a day and I am behind in answering many of them. But here is one I want to answer now for everyone:
"Perhaps you should consider making access to you via your website for your pro readers more available."
"Everyone wants to blame someone else when things go wrong. I am not writing this because I want to blame you. You have good format with your daily comments and a lot of other good stuff you post for your readers; you also tell us about how you are trading and are transparent about all this."
"As you know, the gold market is volatile, and any profit you make can we lost quickly."
"You were quite exuberant about 10 days ago, and I think, you thought as I thought, we were going to get a great August. So much so, that one might even risk going on margin to take a advantage of a great move. Instead, we have gotten quite a haircut—another sell off that I did not expect to be so bad. So you set your stops at support, and you then find you have lost most of your profits, and you feel that the “they” have done it to you again."
"It is always difficult to know when to sell. I thought on this cycle after the nice moves this month, we might get a close move back, then a nice shot up, as the XAU showed strength and consolidation. Instead I am left holding the empty bag."
"It seems to me now after this haircut that you take profits whenever you can in this gold market. There are just many factors out there—the big money—coming in and out at the drop of a hat and then quickly moving out the moment they think gold is only a momentary play."
"I think you were also optimistic about the potential of August gold stocks; I notice you are very silent now as you have probably taken a hit like most of us out here. I am going to tighten my stops considerably. Any comment?"
My reply -
Yes, I was very excited when the XAU finally broke 95 and that prompted me to carry over that excitement in to my August monthly newsletter. I had been talking about the 95 level for almost 6 months and breaking it was an important technical milestone. We then saw the stocks rally even more on tremendous volume.
Although I mention the XAU action almost every day in the pro pre-market commentary, I have been talking about it less frequently in the basic section. The main reason is that I am applying the principles that I wrote in my monthly newsletter when it comes to buying and holding a position. I am personally not watching gold and the XAU trade as frequently as I was doing. I don't think think it does one any good to do that. Even checking it on a daily basis isn't necessary, although I am in a position where I must do that, because of clients and the website. All you really have to do is look at it every couple of days.
This is how gold stocks are going to trade going forward. It is what they have always done. Rally hard and then have sharp, quick, and nasty corrections. Gold stocks are volatile and if you watch them too closely when you own a position you will tend to get too excited when they go up and fall into despair when they drop from thinking about the profits you lost when they were at their highs.
I think it is a mistake to try to trade in and out, thinking you can sell at the peaks and buy at the bottoms consistently. It isn't that easy. What happens if you sell and it doesn't pullback, or doesn't pullback as much as you think it should and miss buying back in?
In the pre-market section I post lots of stocks a month that I think one should trade for short-term trades - get in, put a tight stop, if it goes up for a few days sell and move on. Most of these are tech stocks and I think that this is what one should do with them as a whole, because I don't believe the Nasdaq is in a bull market. I do not believe tech stocks - or most stocks for that matter - are going to go higher like gold stocks will. In bull markets you should try to buy and hold, in bear markets or markets going sideways trading in and out is the best course of action. The thing is it is 10 times more difficult to do this and make money and that is why bear and sideways markets grind people down so easily.
Maybe the best thing to do is buy a smaller gold stock position so that you can better weather the corrections. Or else have a core position and then a trading position. Everyone has to have positions and strategies that mesh with their own needs and personality.
I'm personally holding and do not plan on selling unless I become convinced that the uptrend that began in May for gold stocks is over. I would start to worry some if the XAU closed below 95 and even more if it closed below 92.33, but the most important indicator is the XAU/gold ratio. As long as that remains in an uptrend and the XAU stays in its channel the picture is bullish - and I think it will remain that way for the rest of the year.
I can keep up with that trend with a simple alert on the XAU and a look at the charts every couple of days. My plan is to keep everyone up to date on what I am seeing once or twice a week and then to make more gold stock recommendations when we have pullbacks that have run their course. I want to recommend gold stocks on dips. So at the moment that is what I am waiting for - this dip to run its course.
Energy Stocks:
How many people do you know have been bullish on oil stocks for the past year and have bought and held throughout the rally? Not many, if anyone I bet. And a year from now, when gold stocks have gone up, not even many gold bulls will have bought and hold.
We saw a quick drop in the energy sector off of its highs last week, but there is no sign that the move is over. In fact, on Friday there were important reversals made in many of the high yielding Canadian Royalty trusts such as PWI, PVX, and PGH. PVX has been on the recommended list for some time now along with energy giant, BHP.
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