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Gold Bulls Get Defensive...For Now


For the past three weeks, gold bulls have been on the defensive nearly every single day and are feeling like "we're all going to die," but the good news is that this sort of sentiment has also tended to be the low within this wild trading range.

Yesterday I drew up a chart of the HUI, seen below, partly for a little humor but also in order to graphically display how most gold bulls are probably feeling right now.

I've never seen so many swings in such a tight trading range, especially when the trading range continues to get more and more narrow like this one has, but it is what it is. For the past three weeks, gold bulls have been on the defensive nearly every single day and are feeling like "we're all going to die," but the good news is that this sort of sentiment has also tended to be the low within this wild trading range.

Click to enlarge

Despite what's been a tough couple weeks, the HUI managed to close above not only Friday's intraday low yesterday but also above its closing low of two weeks ago, which is a positive divergence from a gold price that broke to a new low for the move since the April peak last week. So, for now, "the low" for the shares continues to be the one that we put in two weeks ago , which is positive.

As long as that trend of higher lows since October continues, it's a technical positive, even though the more important technical indicator is probably the XAU/Gold ratio breaking its downtrend since the ratio's peak in Feb 2006. Breaking that downtrend has kicked off every big upleg in the gold shares since 2001, and as of today we're very close to doing so, but even doing that doesn't necessarily guarantee anything either. In the end, the fundamentals are what really matters...

The fact remains that rising bond government yields in the context of a steepening yield curve is typically inflationary, and that's historically bullish for gold and bearish for the dollar.

That admittedly hasn't been the case over the last couple of weeks, and there are all sorts of reasons why this has probably occurred (namely Spain's central bank dumping nearly all her gold reserves from March-May). But let's also not forget that both gold and its shares initially traded down following 9/11 back in 2001 too, even though the massive liquidity injections that occurred at the time and other factors eventually resulted in not only a top in the dollar a few short months later but a virtual meltup in the gold complex over the next eight months in anticipation of the inflation (or re-flation as many dubbed it then) that would follow. Sometimes, the market just gets it wrong at first. I continue to believe that's the case here too.

A virtual crash in the bond market is the current excuse for traders to get flat and "clear the sheets" in all asset classes, including gold, but as people begin to appreciate why bond yields are rising they're going to realize how bullish that environment is for gold. After all, bonds aren't falling because of fear of the Fed or "tight money." Long-term yields are rising as a result of rising global inflation, a chronically weak dollar, and foreign central banks that increasingly appear to be recognizing that trying to prop up the dollar is a losing proposition, which also perhaps explains why foreign central banks appear to have completely deserted the US bond market and have instead moved exclusively into the extreme short end, driving US 3-month bill yields over 50 bps below fed funds even as long-term yields have risen over the past several weeks. The Fed is trapped between rising inflation and the housing bust, Heli-Ben and friends won't be raising interest rates anytime soon (at least not until the end of this year when we get past the bulk of the ARM resets). Thus, stagflation will continue to be the name of the game, and rising long-term interest rates are part of that game, as is a rising gold price.

This is what I come back to at the end of the day despite what has been a disappointing April-June period for both the yellow metal and its shares, especially when gold bulls, myself included, have actually been looking for just such a break in the bond market that would effectively end the secular disinflationary trend in long-term US bond yields and set the stage for a new secular inflationary trend leading to higher long-term US bond yields...

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Position in gold shares, GDX calls

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