Gold Overboughtness Risk

Gold has been consolidating high since early August, when it rocketed parabolic on colossal gold-ETF demand. That 6-week-old sideways drift has worked off some greed and overboughtness, but plenty still remains. So gold isn’t out of the woods yet for this essential sentiment-rebalancing selloff. With residual overboughtness still extreme, gold faces considerable downside risk heading into its biggest seasonal selloff.

Across the financial markets, absolute price levels usually don’t matter much in technical and sentimental terms. Though they are important fundamentally. Supply and demand always converge to drive prices to sustainable levels, and over time traders come to accept them as normal. But how fast prices surged or plunged to current prevailing levels is exceedingly important, greatly affecting their short-term staying power.

The faster prices soar, the more excited traders grow about chasing that profitable upside momentum. As their greed flares and morphs into euphoria, they throw increasing amounts of capital at the fast-climbing prices. But such big and aggressive buying is never sustainable for long. Soon greed sucks in everyone interesting in buying anytime soon, exhausting their capital firepower. The price peaks leaving only sellers.

That spawns a necessary and healthy correction to rebalance sentiment and technicals. The greed and overboughtness driven by the frenzied buying into the crest have to be largely eradicated. That can either happen rapidly in sharp corrections or slowly through high consolidations. They need to hammer gold low enough, or hold it down long enough, to work off excessively-bullish sentiment and greatly-overextended technicals.

Fast corrections are far more beneficial to speculators, granting deeper buy-relatively-low opportunities sooner. Investors generally prefer longer high consolidations, as they are much less volatile spawning much less anxiety. Gold has definitely taken the latter route far, meandering sideways in a fairly-tight trading range since early August. But corrections can still emerge later in high consolidations, surprising many.

Gold is nearing a major seasonal juncture which really compounds its near-term downside risk. This metal’s biggest seasonal selloff of the year in modern bull-market years typically erupts between late September to late October. With gold still extremely overbought and greed quite high heading into this seasonally-weak span, the odds of gold’s high consolidation rolling over into a full-blown correction are mounting.

This first chart of gold’s price action in this secular bull shows how outsized this metal’s latest upleg grew. Gold’s technicals are superimposed over an overboughtness measure still flashing warnings despite the recent high consolidation since gold peaked, which I’ll explain shortly. While gold surging to new record highs is awesome, it rocketed up there too far too fast to be sustainable. That necessitated a rebalancing selloff.

Gold’s recent post-stock-panic upleg has proven incredibly strong. Back in March, gold got sucked into the rare stock panic fueled by governments’ heavy-handed lockdowns attempting to slow COVID-19’s spread. Stock panics’ epic fear temporarily infecting gold isn’t unusual. Traders get so scared they rush to dump almost everything. Their flight into cash catapults the safe-haven US dollar higher, unleashing gold selling.

Gold plummeted 12.1% in just 0.3 months into the dark heart of that stock panic, bottoming a couple trading days before the US stock markets. When the US dollar stopped rocketing higher, gold reversed hard and started surging. Big mean-reversion rallies are also normal after stock-panic pummelings, and gold’s was textbook-perfect in April, May, and June. It was rallying higher in a measured, sustainable fashion.

Up until mid-July, gold’s mean-reversion upleg remained in the strong uptrend that was established by this secular bull’s previous upleg leading into mid-March’s stock panic. Gold powered 42.7% higher over 18.8 months in that, proving this bull’s biggest and longest upleg. But in late July gold started shooting parabolic! It burst out of that stable uptrend to soar vertically, hitting a series of 9 new all-time-record highs.

That was fueled by stock traders rushing to buy huge amounts of gold-exchange-traded-fund shares, led by the world-dominating GLD SPDR Gold Shares. My popular essay last week detailed that incredible buying spree, which was interestingly led by young millennial traders. Hedge funds really amplified millennials’ gold-ETF trades, instantly front running them using computers to trade on real-time order-flow data!

So in just three weeks from mid-July to early August, gold soared an incredible 14.9% higher! As this chart shows, that was a vertical parabolic surge in the context of this bull market. That generated crazy levels of greed and euphoria, leaving gold universally loved and everyone wildly bullish on it. It catapulted gold to extraordinarily-overbought levels, challenging those that helped slay gold’s previous secular bull.

Overboughtness is a measure of how far and fast prices run compared to some underlying baseline. An ideal one is prices’ trailing 200-day moving averages. Since 200dmas gradually follow prices, they never become obsolete like static baselines as prevailing price levels change. And the heavy smoothing effect of 200dmas distills out volatility, leaving a great gradual dynamic baseline from which to compare price moves.

Well over a decade ago, I developed a trading system based on prices’ relationships with their 200dmas which I called Relativity Trading. It quantifies overboughtness and oversoldness by looking at price levels relative to their 200dmas, hence the name. When a price is divided by its 200dma, that yields a multiple in this case called Relative Gold or rGold. Charting these Relativity multiples over time often reveal trends.

Relativity charts collapse that all-important 200dma baseline to flat and horizontal at 1.00x, and recast all gold price action around it. That expresses how far gold has stretched either over or under its 200dma, in constant-percentage terms that are perfectly comparable over time regardless of the prevailing gold-price levels. In late July, I explained rGold in more depth in an essay warning about mounting gold overboughtness.

Relativity trading ranges are defined based on the past 5 calendar years of data, which translates into a gold trading range between 0.92x to 1.14x this metal’s 200dma. Anytime gold falls below 92% of its key 200dma, it is extremely oversold. And anytime gold surges above 114% of its 200dma, it is extremely overbought. This year gold faced no overboughtness extremes until millennial Robinhooders rushed in.

Heading into mid-March’s stock panic, gold only peaked at 1.127x its 200dma while rGold hit 1.130x at best. There’s no need to worry about extreme overboughtness until that metric exceeds 1.14x. While gold’s post-panic mean-reversion upleg was strong, it didn’t challenge that overboughtness warning zone until late July. Gold’s big-yet-orderly 23.4% surge in the 4.0 months out of the stock panic nadir didn’t get overextended.

By early July gold had rebounded and rallied far enough to stretch to 1.135x its 200dma. But that 1.14x threshold didn’t get crossed until late July. Once gold runs so far so fast that it extends more than 14% over its 200dma, a healthy rebalancing selloff is increasingly likely. But the momentum-chasing gold-ETF-share buying was so frenzied that gold kept on rocketing higher becoming ever-more overbought.

That culminated in an absolutely-stunning rGold read of 1.260x on August 6th when gold peaked at a dazzling new all-time-record high near $2062! It is exceedingly rare for gold to rocket so far so fast that it stretches 26% above its 200dma. The last time anything like that had been witnessed was way back in early September 2011, 8.9 years earlier. And that episode of extraordinary overboughtness didn’t end well.

Just a couple weeks before, gold’s last secular bull had crested at a then-all-time-record high of $1894. The epic greed and euphoria then catapulted rGold to an incredible 1.286x! But that super-extreme level of overboughtness would soon prove bull-slaying. Right when gold looked so shiny that everyone expected it to keep powering higher indefinitely, a secular bear was being stealthily born that proved devastating.

That would maul gold a massive 44.5% lower over the next 4.3 years! Extraordinary overboughtness is nothing to be trifled with. Yet odds are early August 2020’s similar rGold extreme of 1.260x won’t also kill today’s secular gold bull. Why? It is still quite small and young by secular-gold-bull standards, clocking in at a 96.2% gain over 4.6 years. Gold’s previous secular bull was vastly larger, soaring 638.2% across 10.4 years!

But epic overboughtness still caps gold-bull uplegs, making rebalancing selloffs necessary. While these can take the form of either fast corrections or slow consolidations, the more overbought gold gets the greater the odds of the former. An excellent example came in this gold bull’s maiden upleg that peaked in early July 2016 at 1.151x gold’s 200dma. That was extreme overboughtness above rGold’s 1.14x upper resistance.

Over the next 5.3 months gold plunged 17.3% in a serious correction! That not only worked off all the excessive greed and overboughtness when that upleg peaked in euphoria, but replaced them with fear and extreme oversoldness. This gold bull’s three previous corrections have averaged 14.3% over 4.1 months each. That is definitely deep enough and long enough to eradicate greed and restore balance.

Today’s correction following this gold bull’s fourth upleg hasn’t yet come anywhere close to conforming to that established precedent. Gold’s initial post-peak selloff was very sharp, with this metal plummeting a violent 7.5% in just 3 trading days or 0.2 months after early August’s peak! But that is still the full extent of gold’s rebalancing selloff, as it hasn’t returned to those lows on a closing basis since that flurry of selling.

Gold bounced at $1906 mere days after closing at $2062. But that nascent correction quickly stabilized into the tight high consolidation seen since, where gold has averaged $1952 since that last upleg crested. Is it reasonable to see gold’s smallest and shortest correction of this bull following its second-largest and sharpest-by-far upleg hitting overboughtness extremes? Probably not, with nothing close to being rebalanced.

That day gold’s correction seemingly climaxed with a brutal 5.9% daily plunge to $1906, rGold still closed way up at 1.160x. That’s not only above that 1.14x extreme-overboughtness threshold of its trading range, but still higher than that 1.151x peak of this gold bull’s first upleg. And gold’s overboughtness has not improved much since. The lowest this rGold multiple has been since early August is 1.143x in early September!

Including both its shooting-parabolic phase into early August and the high consolidation since, gold has continuously remained extremely overbought for over 8 consecutive weeks! That is why residual greed and bullishness remain so high. Enthusiasm for the yellow metal hasn’t waned much, with it still widely touted as a great trade and investment. Corrections don’t end until nearly everyone is down on gold again.

Every previous correction in this gold bull not only well exceeded 10%, but hammered gold back down well under its 200dma. So far in this current rebalancing selloff, gold hasn’t even hit formal correction territory and it remains way above that 200dma baseline. That implies the necessary gold selling hasn’t run its course yet. That is evident in gold’s driving gold-ETF capital flows which I discussed in last week’s essay.

While gold could grind sideways for many more months until bullish sentiment fades to bearish, and eventually converge with its 200dma, that’s not likely for many reasons. There are plenty of catalysts that could spark the overdue gold selloff. They include US stock markets surging again, the oversold US dollar rallying, millennial traders exiting their gold-ETF positions en masse, and how US elections play out.

But there’s another one I’ve been increasingly thinking about given the timing, seasonals. Gold is on the verge of falling into its biggest and sharpest seasonal selloff of the year. This next chart was taken from my last look at gold and gold-stock seasonals in late July. It distills out how gold has fared in modern gold-bull years. Each year is individually indexed to the prior year’s close, then these are averaged together.

Gold has enjoyed a strong seasonal uptrend in its modern bull-market years of 2001 to 2012 and 2016 to 2019. 2020 isn’t included yet since this year remains a work in progress. Gold marches higher in three seasonal rallies, its autumn, winter, and spring ones. The autumn rally is the second-largest one, which averages 6.2% gains before topping in late September. That major seasonal peak happens right about now!

Gold crests on September’s 15th trading day on average, which translates to September 22nd this year. Gold’s recent autumn rally was prematurely truncated in early August when excessive buying exhausted itself. Gold’s high consolidation since has come in a seasonally-strong time. But between that autumn-rally peak and the dawn of gold’s winter rally, gold tends to correct sharply. That comes over the next month.

Between late September to late October, gold has retreated an average of 1.9% in these modern gold-bull years. That might not sound like much, but it is gold’s sharpest seasonal decline by far. Gold’s other two seasonal corrections into mid-March and early June average 1.4% and 1.2% retreats. And when gold needs to correct after it has run too far too fast, seasonal weakness way exceeds that heavily-smoothed average.

The still-necessary gold selling after early August’s extraordinary levels of overboughtness is far more likely to materialize in this seasonally-weak time. That seasonal lull is normally caused by Indian gold buying for festival season drying up before holiday buying starts spinning up in the western world. Both of these trends are likely to prove weaker than normal this year, exacerbating any technical gold selling.

Indians are shrewd price-conscious gold buyers, and rupee gold prices are still trading way up near recent lofty all-time-record highs. Indians are generally gold bargain hunters, not momentum chasers like American millennials. And with such deep economic scarring from governments’ economic lockdowns, jewelry buying has cratered this year. That might not recover anywhere near a normal holiday-buying season.

So if this recent high consolidation in gold is going to roll over into a full-blown correction, this coming seasonal-lull month is the time it is most likely to happen. And just like buying begot more buying into early August’s peak, selling will cascade. As soon as gold starts to break down technically, traders will increasingly sell. The more selling they do, the farther gold will fall. That will drive even more selling.

Key technical levels will exacerbate this vicious circle. Many technically-oriented traders including the hyper-leveraged gold-futures speculators closely watch gold’s 50-day moving average. That is running $1926 as of the middle of this week. A decisive close under there will spook traders. Next comes gold’s correction-to-date low of $1906 in mid-August, and then the psychologically-heavy $1900 big round number.

Once gold is pushed below those key technical levels, it is a long way down to gold’s 200dma following way below at $1703! If this necessary and healthy gold correction simply extends to this gold bull’s average of 14.3%, we’d be looking at a major bottoming far lower near $1767. Wherever that appears, it has to happen over a bigger and longer time frame than gold’s 7.5% selloff at worst so far over just 3 trading days.

The millennial Robinhooders and their hedge-fund imitators that flooded into gold-ETF shares at frenzied rates into early August are weak hands. They bought high in peak euphoria, so their losses will snowball fast as gold corrects. That could lead to massive symmetrical selling in gold-ETF shares, led by GLD and to a lesser extent the IAU iShares Gold Trust. Big differential gold-ETF-share selling would hammer gold.

Both speculators and investors should embrace these inevitable rebalancing corrections, as they yield the best mid-bull buying opportunities within ongoing bull markets. That is when to aggressively redeploy in gold, gold ETFs, gold-stock ETFs, and individual gold stocks with superior fundamentals. Bulls’ inexorable upleg-correction cycles are great boons for traders, greatly expanding potential gains to be won in those bulls!

The bottom line is the persistent extreme overboughtness in gold remains a serious downside risk. After shooting parabolic into early August, the high consolidation since has yet to rebalance away excessive greed and extreme overboughtness. Yet that still has to happen before this gold bull’s next major upleg can start marching higher. After such a vertical upleg euphorically climaxing, a correction remains highly likely.

Gold’s technicals are still very stretched heading into its biggest seasonal pullback of the year, running over the next month or so. Any material selling could easily force gold to break below key technical levels not far under current prices. That would unleash both gold-futures and gold-ETF-share selling that could easily cascade. But the resulting overdue gold correction will create excellent mid-bull buying opportunities.

At Zeal we started aggressively buying and recommending fundamentally-superior gold and silver miners in our weekly and monthly subscription newsletters back in mid-March right after the stock-panic lows. We layered into dozens of new positions before gold stocks grew too overbought, which were stopped out recently at huge realized gains running as high as +199%! Our subscribers multiplied their wealth within months.

To profitably trade high-potential gold stocks, you need to stay informed about what’s driving gold. Our popular newsletters are a great way, easy to read and affordable. They draw on my vast experience, knowledge, wisdom, and ongoing research to explain what’s going on in the markets, why, and how to trade them with specific stocks. Subscribe today and take advantage of our 20%-off sale! Corrections are the time to do your gold-stock homework, preparing to redeploy as they pass.

Adam Hamilton, CPA

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