The last sell signal in the gold sector was a dud.
Last month, the Bullish Percent Index for the gold sector (BPGDM) triggered a sell signal when it turned lower from overbought conditions. The Gold Bugs Index (HUI) was trading for about $280 per share at the time. And I warned that gold stocks would likely be lower in the weeks ahead.
Sure enough, HUI fell for a few days. It lost about 7% over the next week – dropping to $260. Traders who were quick to act had a chance to lock in good gains on that decline.
But, the gold sector quickly reversed course. The BPGDM turned higher earlier this month. And HUI put on an explosive rally – all the way up to 310.
I’m still wiping the egg off of my face. But I’m not buying gold stocks right here – because the BPGDM is on the verge of another sell signal.
Take a look…
In most cases, a sector is overbought – and subject to a correction – when its BPI rallies above 80 (meaning 80% of the stocks are trading in bullish technical patterns).
A sector is oversold when the BPI dips below 30. The BPI generates a sell signal when it turns lower from overbought conditions. We get buy signals when the BPI turns higher from oversold levels.
At the current reading of 89, the BPGDM is in extremely overbought territory. It will generate another sell signal when it turns lower.
Of course the gold sector could rally from here. Of course the BPGDM could still work higher towards its maximum reading of 100.
Anything can happen.
From a risk/reward perspective, however, buying the gold stocks right here – with the BPGDM so extended – doesn’t offer much reward. And the risk could be substantial.
Gold stocks typically fall hard following a BPGDM sell signal. The various signals over the past four years led to declines of anywhere from 12% to 30%.
The sell signal in early June, though, yielded only a small decline. So traders might be tempted to disregard the potential for a meaningful decline this time around.
That’s probably a mistake.
The BPGDM has proven to be a reliable indicator for pointing to reversals in the gold sector. With it on the verge of its third flashing sell signal in three months, it seems to me there’s probably more risk in the gold sector than many traders currently appreciate.
At the risk of having to wipe even more egg off of my face next month, I suspect most gold stocks will be lower in the weeks ahead.
Best regards and good trading,
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Jeff Clark
Editor, Market Minute
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Source: Jeff Clark Trader