Opinion: Why bullishness on gold is likely to prompt a drop in prices in coming sessions

New York (Feb 21)  When gold and gold stocks struggle in coming weeks, as I expect they will, it won’t be because the COVID-19 threat has decreased.

Instead, they will have been sabotaged by the excess bullishness that currently prevails among gold-market investors.

This isn’t to say a lessening of the virus’ threat wouldn’t also cause gold to recede from its recent seven-year high. But my argument is that gold will be weak in coming weeks even if the coronavirus remains just as much the public health emergency it is today.

To appreciate why, consider the average recommended gold market exposure level among several dozen short-term gold timers I monitor (as measured by the Hulbert Gold Newsletter Sentiment Index, or HGNSI). (This average is plotted in the accompanying chart.) It currently is higher than 96.4% of all daily readings of the past 20 years.

In the past, whenever the HGNSI has been this high, gold and gold-mining stocks performed poorly on average. The relevant data are summarized in the table below. It shows the returns of gold and the VanEck Vectors Gold Miners ETF GDX, +2.02% in the wake of HGNSI readings as high as we’re currently seeing, as well as in the wake of low readings that were just as extreme at the other end of the historical distribution.

When HGNSI is … Average gold bullion return over subsequent month Average gold bullion return over subsequent quarter Average GDX return over subsequent month Average GDX return over subsequent quarter 

In the 96th or higher percentile -0.10% 0.10% -4.00% -5.60%

In the 4th or lower percentile 0.20% 1.10% 0.70% 2.90%

Notice that gold bullion’s subsequent one-month and three-month returns are flat to sharply lower following extreme levels of gold bullishness. Those are the historical precedents with which the gold market must contend in the next several weeks.

By pointing this out, I am in no way trying to minimize the economic consequences of the coronavirus, which are considerable. But, human nature being what it is, investors most likely are overreacting: When things take a turn for the worse, investors catastrophize the situation and think the world is coming to an end — just as, when things start to look up, investors jump on the bullish bandwagon and think that the market can only go up.

The truth, as it always is, is somewhere in the middle. The contrarian bet is simply that sentiment extremes will correct themselves and recede back toward that middle.

And that’s why you shouldn’t be surprised if gold is weak in coming weeks.


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