Further downside in the gold price is likely
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Over the past month or so, we have been watching as the pendulum began to swing in favour of the ASX 20 Leaders and away from the smaller end of the market.
It has been an interesting time and a bit of a slow process but last week we saw some pretty clear-cut action, as the ASX 20 Leaders/All Ords ratio completed a lengthy base formation.
We also have been monitoring the ASX Small Ordinaries/All Ordinaries ratio and the ASX Midcap 50/All Ordinaries ratio.
In recent reports I have highlighted the proximity of the 2015 uptrend. I suggested a couple of weeks ago that the odds favoured a break of that uptrend: last week saw a decisive break.
I don't know how long this turn in performance can last but it is unlikely to reverse in the short term.
Both the banks and resources have outperformed the broader market in recent months. This came as the "yield plays" moved out of favour.
I highlighted the Utilities, Telecommunications, and REITS during August as they began to break down in relative-performance terms. I expect continued underperformance.
We have also reviewed the ASX Consumer Staples on a couple of occasions, most recently in the last report. The sector began to outpace the broader market in July and then paused in September.
Last week saw another burst of outperformance, completing the month-long consolidation phase. Further gains are likely.
As far as the resource/industrial ratios are concerned, there were further gains in favour of the resources last week. Resistance levels have been overcome.
However, in looking at the ASX Financials/ASX Materials ratio, the situation is unresolved. The ratio did break below support the week before last but it has been reclaimed. This is an interesting one--let's see what happens next.
Although the ASX 100 Resources Index gained 1.8 per cent last week, it wasn't all good news on the resource front. BHP Billiton (ASX: BHP) and Woodside Petroleum (ASX: WPL) rose by 4 per cent. Rio Tinto (ASX: RIO) gained less than 1 per cent and Fortescue Mining (ASX: FMG) was flat.
But the ASX Small Resources fell by just under 6 per cent as the gold price closed the week 5 per cent lower. Northern Star Resources (ASX: NST), which has been a great performer over the past few years, dropped 17 per cent, taking the loss from the July peak to 32 per cent.
The fall in the gold price has taken the precious metal back to its 200DMA, but it has broken the uptrend from the 2015 lows.
I noted a few weeks ago that gold's failure to advance at this seasonally strong time of the year was a concern and this break adds to the cautionary outlook.
Admittedly, gold is still trading above its 200DMA and as I often point out the 200DMA is regarded as an important support level, but there is no suggestion that a quick turnaround is imminent.
The Australian and US gold indices are also close to their 200DMAs.
I was looking at some interesting data from the Commitment of Traders report (known as COT) over the weekend.
Many of you will know of this report but for those that don't here is a summary, taken directly from Wikipedia.
"The weekly report details trader positions in most of the futures contracts markets in the United States. Data for the report is required by the Commodity Futures Trading Commission (CFTC) from traders in markets that have 20 or more traders holding positions large enough to meet the reporting level established by the CFTC for each of those markets ... the report provides a breakdown of aggregate positions held by three different types of traders: 'commercial traders,' 'non-commercial traders' and 'non-reportable.'"
"Commercial traders are sometimes called 'hedgers,' 'non-commercial traders' are sometimes known as 'large speculators,' and the 'non-reportable' group is sometimes called 'small speculators'.
"As one would expect, the largest positions are held by commercial traders that actually provide a commodity or instrument to the market or have bought a contract to take delivery of it ... there is also participation in these markets by speculators that are not able to deliver on the contract or that have no need for the underlying commodity or instrument.
"They are buying or selling only to speculate that they will exit their position at a profit, and plan to close their long or short position before the contract becomes due.
"In most of these markets the majority of the open interest in these 'speculator' positions are held by traders whose positions are large enough to meet reporting requirements.
"The remainder of holders of contracts in these futures markets, other than 'commercial" and 'large speculator' traders, are referred to by the CFTC as 'non-reportable'. This is because they don't meet the position size that requires reporting to the CFTC. (Thus they are 'small speculators'.)"
When small speculators hold excessive long or short positions, it is a warning that the trend may be about to change. The theory is that speculators are often wrong at turning points.
Commercials on the other hand, those that buy a commodity for a specific purpose, are more likely to be correct.
Recently, the speculative long interest in gold has been extremely high, higher in fact than it was in 2011.
We will have to wait for next week's data (taken Tuesday, released Friday) to see if there has been a significant change in the speculative interest, but at this stage it does appear as though further downside in the gold price is likely.
The bulls need to be shaken out if there is to be a resumption of the uptrend.
Of course there are times when the speculative long interest is high and the gold price has still advanced, but we need to see some positive signs before assuming the worst is over for gold.
The US dollar should, in my opinion, continue to strengthen and this is likely to continue to put downward pressure on gold.
"Black gold," as oil is often referred to, continued to advance last week. It now sits just below its key resistance level.
Finally, a quick comment on the US market.
I said in the last report that I believed the US Banks Index and the Dow Transports were at important levels. The latter was testing its key barrier and the Banks Index was testing the breakout level from the 2015 downtrend. So we had both indices at an important juncture.
The good news is that the banks rallied, keeping the break of the downtrend intact. Unfortunately, the Transports could not break resistance.
The S&P 500 was basically flat again.
So we continue to wait for some decisive action in the US equity market.
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