Precious Metals Set to Get More Precious
After double-bottom formation, gold and silver could spark higher.
In my previous article, Three Signs That the Bottom in Gold & Silver is Near, I emphasized the meaning of sentiment and how one can analyze it to gain advantage over other market participants. I received very positive feedback after posting it, so I decided to dedicate a part of this week's article to it once again.
There are 2 common indicators that can help gauge sentiment: the S&P Energy Sector Bullish Percent Index and the Gold Miners Bullish Percent Index. From my point of view as a precious-metals investor, it's the latter that's particularly interesting. (Charts are courtesy of stockcharts.com.)
The Gold Miners Bullish Percent Index is a market breadth/momentum indicator and is calculated by dividing 2 numbers: the amount of gold stocks on the buy signal (according to the point-and-figure chart, which emphasizes strong moves while ignoring small ones) and the amount of all the gold stocks in the sector. If every gold stock is rising, then the value of the index will be at 100%.
This raises a red flag: If everyone interested in the market is already in, then the top will soon emerge. If we're looking at sentiment, substantial momentum usually corresponds to investors eager to jump in at quickly rising prices because they believe prices will continue to go higher, and they don't want to be left behind.
If we said that at 100% the indicator shows overbought conditions, then you can see on the above chart that, at the current 70% level, the indicator isn't extremely overbought nor is it oversold. The Gold Miners Bullish Percent Index is no longer signaling that lower prices are to be expected, which was the case several weeks ago. Since the value of the index doesn't need to be at the oversold levels for a local bottom to form (though it's helpful in timing the major bottoms), we might need to look for additional tools to help us.
If you look closely, you'll notice 2 additional tools in the above chart. The Relative Strength Index (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions.
The RSI ranges from 0 to 100 with an asset deemed to be overbought once the RSI approaches the 70 level, meaning it may be getting overvalued and is a good candidate for a pullback. Likewise, if the RSI approaches 30, it's an indication that the asset may be getting oversold and is likely to become undervalued. If you look at the RSI indicator in the above chart, you can clearly see that it just touched the 30 mark.
Another indicator on this chart is the Williams %R -- also a momentum indicator that's especially popular for measuring overbought and oversold levels. Named for its developer Larry Williams, the scale ranges from 0 to -100, with readings from 0 to -20 considered overbought and readings from -80 to -100 considered oversold.
What I find particularly interesting here is that the %R indicator has signaled a "temporary oversold" territory only once in 2009 -- and that corresponded to the long-term buying point (also signaled by the S&P Gold Bottom Indicator) and a powerful rally. The last time the %R indicator for Gold Miners Bullish Percent Index hit the 100 level was on April 17 when gold closed at $869. A powerful rally followed, which took gold to $989 in about 6 weeks.
The same signal has just appeared in the recent days with the Williams %R at 80, which suggests we'll see PMs higher in the not-too-distant future.
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