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Extreme Indicator Alert: A Multi-Month Gold Stock Rally Appears Likely


This indicator has always led to 26% rallies for gold stocks.

On February 20, the RSI (21) for the PHLXGold/SilverSector (INDEXNASDAQ:XAU) closed at 26.14. This reading was the lowest since August 31, 1998. Overall it was the 17th lowest reading out of 7,365 trading days since the ^XAU's December 1983 inception. That places it in the 0.22% percentile. This article will examine what has happened after low XAU RSI readings.

On the morning of August 9, 2011 I released an article entitled Low RSI of Wilshire 5000 Says It's Time to Buy, Then Sell. The basic premise of the article was that when stocks traded at am uber-low RSI, they typically staged a brief rally and then experienced a pullback. These pullbacks were soon followed by rallies of at least 23%. The day I wrote the article, the S&P (INDEXSP:.INX) put in a bottom and rallied by 11.7% over the next 22 days. Sure enough, the S&P then corrected by 12.6%. Since their early October 2011 bottom, stocks have rallied by 45% without even pausing for a 10% correction.

A similar situation may be playing out now in gold stocks. In early March I wrote "once gold stocks bottom, they seem to have a 15- to 20-day rally." From March 6 to March 22 gold stocks staged a 16 day 8% rally. From the March 22 high to the April 4 low, gold stocks collapsed by 12.1%.

The 16 lowest XAU RSI readings were in six groups as there were a lot of low readings in 1984 and 1987. Let's take a look at the top 10 oversold "groups" for gold stocks (showing the lowest RSI in each "group"):

In all the previous instances, gold stocks went up at least 26% from the signal date to the high (similar to the 23% S&P rallies mentioned earlier in the column).

When the signal is initially given, gold stocks always put in a major low within 0-23 days and then stage a rally (like the S&P example). After the rally comes a pullback (like the S&P example). This sets the stage for a second rally (like the S&P example).

The dates highlighted in green are the three times the retest went lower than the initial low of the first three weeks. Of the top four rallies from the signal to the high, three of those were when gold stocks hit new lows during their retest phase. All the top three longest lasting rallies were the three times the retest went on to new lows. This is counterintuitive as you would think the retests that hit new lows exhibited weakness that would manifest in weaker rallies. But this was not the case. The main point of this paragraph is that there are precedents for gold stocks acting poorly 39-81 days after a low RSI reading and then staging a spectacular second rally.

If the ^XAU acts like it has acted over the past 29 years, the reward/risk for buying gold stocks appears to be quite favorable at this point.
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