Gold Price Overboughtness Risk / Commodities / Gold & Silver 2020

Gold has been consolidatinghigh since early August, when it rocketed parabolic on colossal gold-ETFdemand.  That 6-week-old sideways drift hasworked off some greed and overboughtness, but plenty still remains.  So gold isn’t out of the woods yet for thisessential sentiment-rebalancing selloff. With residual overboughtness still extreme, gold faces considerabledownside risk heading into its biggest seasonal selloff.

Across the financialmarkets, absolute price levels usually don’t matter much in technical and sentimentalterms.  Though they are important fundamentally.  Supply and demand always converge to driveprices to sustainable levels, and over time traders come to accept them asnormal.  But how fast prices surgedor plunged to current prevailing levels is exceedingly important, greatlyaffecting their short-term staying power.

The faster prices soar,the more excited traders grow about chasing that profitable upside momentum.  As their greed flares and morphs into euphoria,they throw increasing amounts of capital at the fast-climbing prices.  But such big and aggressive buying is neversustainable for long.  Soon greed sucksin everyone interesting in buying anytime soon, exhausting their capitalfirepower.  The price peaks leaving onlysellers.

That spawns a necessaryand healthy correction to rebalance sentiment and technicals.  The greed and overboughtness driven by thefrenzied buying into the crest have to be largely eradicated.  That can either happen rapidly in sharp correctionsor slowly through high consolidations. They need to hammer gold low enough, or hold it down long enough, towork off excessively-bullish sentiment and greatly-overextended technicals.

Fast corrections arefar more beneficial to speculators, granting deeper buy-relatively-low opportunitiessooner.  Investors generally prefer longerhigh consolidations, as they are much less volatile spawning much lessanxiety.  Gold has definitely taken thelatter route far, meandering sideways in a fairly-tight trading range sinceearly August.  But corrections can still emerge later in high consolidations, surprising many.

Gold is nearing a majorseasonal juncture which really compounds its near-term downside risk.  This metal’s biggest seasonal selloff ofthe year in modern bull-market years typically erupts between late September tolate October.  With gold still extremelyoverbought and greed quite high heading into this seasonally-weak span, the oddsof gold’s high consolidation rolling over into a full-blown correction are mounting.

This first chart ofgold’s price action in this secular bull shows how outsized this metal’s latestupleg grew.  Gold’s technicals are superimposedover an overboughtness measure still flashing warnings despite the recent high consolidationsince gold peaked, which I’ll explain shortly. While gold surging to new record highs is awesome, it rocketed up there toofar too fast to be sustainable.  Thatnecessitated a rebalancing selloff.

Gold’s recentpost-stock-panic upleg has proven incredibly strong.  Back in March, gold got sucked into the rarestock panic fueled by governments’ heavy-handed lockdowns attempting to slow COVID-19’sspread.  Stock panics’ epic fear temporarilyinfecting gold isn’t unusual.  Traders getso scared they rush to dump almost everything. Their flight into cash catapults the safe-haven US dollar higher, unleashinggold selling.

Gold plummeted 12.1% injust 0.3 months into the dark heart of that stock panic, bottoming a couple tradingdays before the US stock markets.  Whenthe US dollar stopped rocketing higher, gold reversed hard and startedsurging.  Big mean-reversion rallies arealso normal after stock-panic pummelings, and gold’s was textbook-perfect inApril, May, and June.  It was rallyinghigher in a measured, sustainable fashion.

Up until mid-July, gold’smean-reversion upleg remained in the strong uptrend that was established bythis secular bull’s previous upleg leading into mid-March’s stock panic.  Gold powered 42.7% higher over 18.8 months inthat, proving this bull’s biggest and longest upleg.  But in late July gold started shootingparabolic!  It burst out of thatstable uptrend to soar vertically, hitting a series of 9 new all-time-recordhighs.

That was fueled by stocktraders rushing to buy huge amounts of gold-exchange-traded-fund shares, led bythe world-dominating GLD SPDR Gold Shares. My popular essay last week detailed that incredible buying spree,which was interestingly led by young millennial traders.  Hedge funds really amplified millennials’gold-ETF trades, instantly front running them using computers to trade on real-timeorder-flow data!

So in just three weeksfrom mid-July to early August, gold soared an incredible 14.9% higher!  As this chart shows, that was a verticalparabolic surge in the context of this bull market.  That generated crazy levels of greed andeuphoria, leaving gold universally loved and everyone wildly bullish on it.  It catapulted gold to extraordinarily-overbought levels, challenging those that helped slay gold’s previous secular bull.

Overboughtness is ameasure of how far and fast prices run compared to some underlyingbaseline.  An ideal one is prices’trailing 200-day moving averages.  Since200dmas gradually follow prices, they never become obsolete like staticbaselines as prevailing price levels change. And the heavy smoothing effect of 200dmas distills out volatility,leaving a great gradual dynamic baseline from which to compare price moves.

Well over a decade ago,I developed a trading system based on prices’ relationships with their 200dmaswhich I called RelativityTrading.  It quantifies overboughtnessand oversoldness by looking at price levels relative to their 200dmas,hence the name.  When a price is dividedby its 200dma, that yields a multiple in this case called Relative Gold orrGold.  Charting these Relativity multiplesover time often reveal trends.

Relativity charts collapsethat all-important 200dma baseline to flat and horizontal at 1.00x, and recastall gold price action around it.  That expresseshow far gold has stretched either over or under its 200dma, in constant-percentageterms that are perfectly comparable over time regardless of the prevailinggold-price levels.  In late July, Iexplained rGold in more depth in an essay warning about mounting gold overboughtness.

Relativity trading rangesare defined based on the past 5 calendar years of data, which translates into agold trading range between 0.92x to 1.14x this metal’s 200dma.  Anytime gold falls below 92% of its key200dma, it is extremely oversold.  Andanytime gold surges above 114% of its 200dma, it is extremely overbought.  This year gold faced no overboughtnessextremes until millennial Robinhooders rushed in.

Heading into mid-March’sstock panic, gold only peaked at 1.127x its 200dma while rGold hit 1.130x atbest.  There’s no need to worry aboutextreme overboughtness until that metric exceeds 1.14x.  While gold’s post-panic mean-reversion uplegwas strong, it didn’t challenge that overboughtness warning zone until lateJuly.  Gold’s big-yet-orderly 23.4%surge in the 4.0 months out of the stock panic nadir didn’t get overextended.

By early July gold had reboundedand rallied far enough to stretch to 1.135x its 200dma.  But that 1.14x threshold didn’t get crosseduntil late July.  Once gold runs so farso fast that it extends more than 14% over its 200dma, a healthy rebalancingselloff is increasingly likely.  But themomentum-chasing gold-ETF-share buying was so frenzied that gold kept onrocketing higher becoming ever-more overbought.

That culminated in anabsolutely-stunning rGold read of 1.260x on August 6th when gold peaked at a dazzlingnew all-time-record high near $2062!  Itis exceedingly rare for gold to rocket so far so fast that it stretches 26%above its 200dma.  The last timeanything like that had been witnessed was way back in early September 2011, 8.9years earlier.  And that episode ofextraordinary overboughtness didn’t end well.

Just a couple weeks before,gold’s last secular bull had crested at a then-all-time-record high of $1894.  The epic greed and euphoria then catapultedrGold to an incredible 1.286x!  But that super-extremelevel of overboughtness would soon prove bull-slaying.  Right when gold looked so shiny that everyoneexpected it to keep powering higher indefinitely, a secular bear was being stealthilyborn that proved devastating.

That would maul gold amassive 44.5% lower over the next 4.3 years! Extraordinary overboughtness is nothing to be trifled with.  Yet odds are early August 2020’s similarrGold extreme of 1.260x won’t also kill today’s secular gold bull.  Why? It is still quite small and young by secular-gold-bull standards,clocking in at a 96.2% gain over 4.6 years. Gold’s previous secular bull was vastly larger, soaring 638.2% across 10.4years!

But epic overboughtness still caps gold-bull uplegs, making rebalancing selloffs necessary.  While these can take the form of either fastcorrections or slow consolidations, the more overbought gold gets the greaterthe odds of the former.  An excellent examplecame in this gold bull’s maiden upleg that peaked in early July 2016 at 1.151xgold’s 200dma.  That was extremeoverboughtness above rGold’s 1.14x upper resistance.

Over the next 5.3months gold plunged 17.3% in a serious correction!  That not only worked off all the excessive greedand overboughtness when that upleg peaked in euphoria, but replaced them withfear and extreme oversoldness.  This goldbull’s three previous corrections have averaged 14.3% over 4.1 monthseach.  That is definitely deep enough andlong enough to eradicate greed and restore balance.

Today’s correction followingthis gold bull’s fourth upleg hasn’t yet come anywhere close to conforming tothat established precedent.  Gold’s initialpost-peak selloff was very sharp, with this metal plummeting a violent 7.5% injust 3 trading days or 0.2 months after early August’s peak!  But that is still the full extent of gold’s rebalancingselloff, as it hasn’t returned to those lows on a closing basis since that flurryof selling.

Gold bounced at $1906 meredays after closing at $2062.  But thatnascent correction quickly stabilized into the tight high consolidation seensince, where gold has averaged $1952 since that last upleg crested.  Is it reasonable to see gold’s smallest andshortest correction of this bull following its second-largest and sharpest-by-farupleg hitting overboughtness extremes? Probably not, with nothing close to being rebalanced.

That day gold’scorrection seemingly climaxed with a brutal 5.9% daily plunge to $1906, rGoldstill closed way up at 1.160x. That’s not only above that 1.14x extreme-overboughtness threshold of itstrading range, but still higher than that 1.151x peak of this gold bull’s firstupleg.  And gold’s overboughtness has notimproved much since.  The lowest thisrGold multiple has been since early August is 1.143x in early September!

Including both its shooting-parabolicphase into early August and the high consolidation since, gold has continuouslyremained extremely overbought for over 8 consecutive weeks!  That is why residual greed and bullishness remainso high.  Enthusiasm for the yellow metalhasn’t waned much, with it still widely touted as a great trade andinvestment.  Corrections don’t end until nearlyeveryone is down on gold again.

Every previous correctionin this gold bull not only well exceeded 10%, but hammered gold back down wellunder its 200dma.  So far in thiscurrent rebalancing selloff, gold hasn’t even hit formal correction territory andit remains way above that 200dma baseline. That implies the necessary gold selling hasn’t run its course yet.  That is evident in gold’s driving gold-ETF capital flows which I discussed in last week’s essay.

While gold could grindsideways for many more months until bullish sentiment fades to bearish, andeventually converge with its 200dma, that’s not likely for many reasons.  There are plenty of catalysts that couldspark the overdue gold selloff.  Theyinclude US stock markets surging again, the oversold US dollar rallying, millennialtraders exiting their gold-ETF positions en masse, and how US elections playout.

But there’s another oneI’ve been increasingly thinking about given the timing, seasonals.  Gold is on the verge of falling into its biggestand sharpest seasonal selloff of the year. This next chart was taken from my last look at gold and gold-stock seasonals in late July.  It distills out how goldhas fared in modern gold-bull years. Each year is individually indexed to the prior year’s close, then theseare averaged together.

Gold has enjoyed a strongseasonal uptrend in its modern bull-market years of 2001 to 2012 and 2016 to2019.  2020 isn’t included yet since thisyear remains a work in progress.  Goldmarches higher in three seasonal rallies, its autumn, winter, and spring ones.  The autumn rally is the second-largest one, whichaverages 6.2% gains before topping in late September.  That major seasonal peak happens right aboutnow!

Gold crests onSeptember’s 15th trading day on average, which translates to September 22nd thisyear.  Gold’s recent autumn rally wasprematurely truncated in early August when excessive buying exhausteditself.  Gold’s high consolidation sincehas come in a seasonally-strong time. But between that autumn-rally peak and the dawn of gold’s winter rally,gold tends to correct sharply.  Thatcomes over the next month.

Between late September tolate October, gold has retreated an average of 1.9% in these modern gold-bullyears.  That might not sound like much, butit is gold’s sharpest seasonal decline by far. Gold’s other two seasonal corrections into mid-March and early Juneaverage 1.4% and 1.2% retreats.  And whengold needs to correct after it has run too far too fast, seasonal weakness wayexceeds that heavily-smoothed average.

The still-necessarygold selling after early August’s extraordinary levels of overboughtness is farmore likely to materialize in this seasonally-weak time.  That seasonal lull is normally caused byIndian gold buying for festival season drying up before holiday buying startsspinning up in the western world.  Bothof these trends are likely to prove weaker than normal this year, exacerbatingany technical gold selling.

Indians are shrewdprice-conscious gold buyers, and rupee gold prices are still trading way up nearrecent lofty all-time-record highs. Indians are generally gold bargain hunters, not momentum chasers likeAmerican millennials.  And with such deepeconomic scarring from governments’ economic lockdowns, jewelry buying hascratered this year.  That might notrecover anywhere near a normal holiday-buying season.

So if this recent highconsolidation in gold is going to roll over into a full-blown correction, thiscoming seasonal-lull month is the time it is most likely to happen.  And just like buying begot more buying intoearly August’s peak, selling will cascade. As soon as gold starts to break down technically, traders will increasinglysell.  The more selling they do, thefarther gold will fall.  That will driveeven more selling.

Key technical levelswill exacerbate this vicious circle. Many technically-oriented traders including the hyper-leveragedgold-futures speculators closely watch gold’s 50-day moving average.  That is running $1926 as of the middle ofthis week.  A decisive close under therewill spook traders.  Next comes gold’scorrection-to-date low of $1906 in mid-August, and then the psychologically-heavy$1900 big round number.

Once gold is pushed belowthose key technical levels, it is a long way down to gold’s 200dma followingway below at $1703!  If this necessaryand healthy gold correction simply extends to this gold bull’s average of14.3%, we’d be looking at a major bottoming far lower near $1767.  Wherever that appears, it has to happen overa bigger and longer time frame than gold’s 7.5% selloff at worst so far overjust 3 trading days.

The millennial Robinhoodersand their hedge-fund imitators that flooded into gold-ETF shares at frenzied ratesinto early August are weak hands. They bought high in peak euphoria, so their losses will snowball fast asgold corrects.  That could lead tomassive symmetrical selling in gold-ETF shares, led by GLD and to a lesserextent the IAU iShares Gold Trust.  Big differentialgold-ETF-share selling would hammer gold.

Both speculators andinvestors should embrace these inevitable rebalancing corrections, as theyyield the best mid-bull buying opportunities within ongoing bullmarkets.  That is when to aggressivelyredeploy in gold, gold ETFs, gold-stock ETFs, and individual gold stocks with superiorfundamentals.  Bulls’ inexorable upleg-correctioncycles are great boons for traders, greatly expanding potential gains to be wonin those bulls!

At Zeal we started aggressivelybuying and recommending fundamentally-superior gold and silver miners in our weekly and monthly subscription newsletters back in mid-March right after the stock-panic lows.  We layered into dozens of new positionsbefore gold stocks grew too overbought, which were stopped out recently at hugerealized gains running as high as +199%!  Our subscribers multiplied their wealth withinmonths.

To profitably trade high-potentialgold stocks, you need to stay informed about what’s driving gold.  Our popular newsletters are a great way, easyto read and affordable.  They draw on my vastexperience, knowledge, wisdom, and ongoing research to explain what’s going on inthe markets, why, and how to trade them with specific stocks.  Subscribe today and take advantageof our 20%-off sale!  Correctionsare the time to do your gold-stock homework, preparing to redeploy as they pass.

The bottom line is the persistentextreme overboughtness in gold remains a serious downside risk.  After shooting parabolic into early August, thehigh consolidation since has yet to rebalance away excessive greed and extremeoverboughtness.  Yet that still has tohappen before this gold bull’s next major upleg can start marching higher.  After such a vertical upleg euphoricallyclimaxing, a correction remains highly likely.

Gold’s technicals arestill very stretched heading into its biggest seasonal pullback of the year,running over the next month or so.  Anymaterial selling could easily force gold to break below key technical levelsnot far under current prices.  That wouldunleash both gold-futures and gold-ETF-share selling that could easily cascade.  But the resulting overdue gold correctionwill create excellent mid-bull buying opportunities.

Adam Hamilton, CPA

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