Getting Short Term Overbought

Here is a brief technical and positioning update on gold. In euro terms, gold has just experienced a scorching rally – as a result, the previously discussed resistance levels in gold’s dollar price have been overcome as well. However, gold seems now quite overbought relative to the euro in the short term, and it also seems quite overbought relative to commodities.

The rally in the HUI index has recently been rejected near the 200 day moving average, and the HUI-gold ratio has pulled back somewhat, which also increases the probability that a corrective/consolidation period has begun.

Also shown below is the net hedger short position in COMEX gold futures (the inverse of the net speculative long position), which has in the meantime reached the highest level since early 2013. In short, everything seems to argue in favor of at least a short term pullback.

However, one reason why it is worth keeping a close eye on things now is that a number of markets – especially currencies – have lately tended to ignore such “overbought” signals. Obviously we don’t know with certainty what will happen next in the gold market. Normally, a correction should be expected, i.e., this outcome has the highest probability at the moment (even a resumption of the bear market cannot be ruled out completely yet, although it has become a lot less likely from a technical perspective).

However, should the correction turn out to be only very shallow and the rally resume quickly, it would be a sign of great underlying strength. It would also signal that faith in central banks is slowly but surely crumbling and that economic confidence is continuing to wane in spite of the recent strength in global stock markets.

Below are updated versions of the charts we showed in our last update, plus a chart of the net hedger position in gold futures:

Gold in dollar, euro and yen terms – important resistance levels have been overcome in all currencies by now (this is also true of gold in Canadian and Australian dollars, as well as in British pounds), however, gold is now quite overbought in all of them, especially in euro terms.

Gold relative to commodities presents a similar picture – a bullish trend, but it is also short term overbought 

The HUI index and the HUI-gold ratio: the advance has been stopped by the 200 day moving average. This could turn out to be just a brief pause, but a correction back to the support area indicated above wouldn’t be terribly surprising. This area needs to hold on a pullback to keep the medium term uptrend intact from a technical perspective 

The net short position of hedgers in COMEX gold futures has reached its highest level since early 2013 (conversely, the speculative net long position has also reached its highest level since then). This also speaks of a slightly overbought market, but there is still room for this position to expand further. Note that gold actually needs speculators to turn increasingly bullish in order to deliver a sustained rally. The positioning data are therefore actually not bearish, but at worst neutral.

Conclusion:

Gold’s recent advance presumably mainly reflects increasing worries of market participants over the euro in the context of recent central bank actions in Europe (SNB peg suspension, ECB QE announcement), as well as rising political risks in the euro area. Not surprisingly, its rally has been strongest in euro terms. Short term the market seems quite stretched now and is likely to correct even if the rally is set to continue. However, the shape and depth of the correction should provide us with further information about the market’s underlying longer term strength, or lack thereof.

Note that gold’s fundamentals remain by and large mixed, as far as they can be quantified. However, concerns over central bank policies and political developments are unquantifiable, but highly important factors driving the gold price, which can override a great many other considerations. A continuation of gold’s advance would therefore also tell us that the market’s concerns over these factors continue to increase, which should eventually affect other financial markets as well (especially risk assets).

Charts by: StockCharts, Sentimentrader