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What gold tells us about stock prices

Summary:
Mid-week market comment: The SPX has risen roughly 400 handles since the December 24 bottom, and it is approaching its 200 dma. Can the market stage a sustainable rally above this key hurdle? Golden clues For some clues, we can turn to the price of gold. The top panel of the chart below shows that gold prices tend to have an inverse correlation with stock prices, and that relationship is especially true now. When stocks rise, gold falls, and vice versa. Here are some clues to the likely direction of stocks from gold prices. First, the long-term outlook for gold prices looks impressive. It is formed a multi–year saucer shaped base. The objective on an upside breakout is about 1560 based on point and figure charting. In the short run, however, the golden rally looks exhausted

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Mid-week market comment: The SPX has risen roughly 400 handles since the December 24 bottom, and it is approaching its 200 dma. Can the market stage a sustainable rally above this key hurdle?

What gold tells us about stock prices

Golden clues

For some clues, we can turn to the price of gold. The top panel of the chart below shows that gold prices tend to have an inverse correlation with stock prices, and that relationship is especially true now. When stocks rise, gold falls, and vice versa.

What gold tells us about stock prices

Here are some clues to the likely direction of stocks from gold prices. First, the long-term outlook for gold prices looks impressive. It is formed a multi–year saucer shaped base. The objective on an upside breakout is about 1560 based on point and figure charting.

What gold tells us about stock prices

In the short run, however, the golden rally looks exhausted and due for a pullback. Gold prices are testing the underside of uptrend resistance. Similarly, the inflation expectations ETF (RINF) is displaying a similar technical pattern of approaching trend line resistance.

When I turn to gold equities (GDX), the silver/gold ratio is exhibiting a negative divergence that is not supportive of further strength. Silver is the poor man’s gold, and it tends to have a higher beta than gold. The underperformance of the silver/gold ratio is therefore another short-term cautionary sign for gold bugs.

What gold tells us about stock prices

In addition, Mark Hulbert pointed out that the sentiment of short-term gold timers is an off-the-charts bullish reading, which is contrarian bearish.

What gold tells us about stock prices

Contrast those sentiment readings with Callum Thomas’ weekly (unscientific) Twitter poll conducted on weekends, which still shows respondents to be net bearish even after last week’s advance. Stock prices are climbing the proverbial Wall of Worry.

What gold tells us about stock prices

In conclusion, while the longer term outlook for gold prices is bullish, this precious metal appears overextended in the short-term. The inverse relationship between gold and stock prices implies a bullish outlook for US equities.

Cautionary tripwires for equities

However, this does not mean that traders should pile into stocks with abandon. The stock market is highly overbought, and it can either consolidate or correct at any time. Here are a couple of cautionary signs that I am watching for.

What gold tells us about stock prices
  1. RSI-14: While the series of overbought readings flashed by the RSI-5 indicator could be signals of “good overbought” conditions, an overbought reading by the longer term RSI-14 indicator has historically been a cautionary sign of an extended market.
  2. VIX below lower BB: In the past, the VIX Index falling below its lower Bollinger Band has also been another cautionary signal for the stock market. Intra-day dips below the lower BB isn’t enough, it’s the closing price that raises the red flag. Watch for it.

My inner trader went long the market earlier this week. He is bullishly positioned, but he is watching these triggers as signals to exit his long positions.

Disclosure: Long SPXL

About Cam Hui
Cam Hui
Cam Hui has been professionally involved in the financial markets since 1985 in a variety of roles, both as an equity portfolio manager and as a sell-side analyst. He graduated with a degree in Computer Science from the University of British Columbia in 1980 and obtained his CFA Charter in 1989. He is left & right brained modeler of quantitative investment systems. Blogs at Humble Student of the Markets.

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