Investment Implications From A Breakout In The Stock/Gold Ratio?

• Technical condition poised for an upside breakout in the stock/Gold ratio
• The significance for equities and gold from an upside or downside breakout.
• Wither the tech stocks?

Technical condition poised for an upside breakout in the stock/Gold ratio

The ratio ($SPX:$GOLD) between the S&P 500 ($SPX) and the Gold price ($Gold), has reached a very crucial level in the form of an eleven year resistance trendline. The trend is bullish, because the ratio and its long-term KST are in a positive mode. While this relationship has started to edge above the trendline, the break is not yet sufficiently strong to enable us to use the word “decisive”.

Chart 1

Chart 2 shows the same relationship, but on a weekly closing basis. The 2015-17 resistance area, or the last 2 ¼-years of the trendline in the previous chart, is shown in greater detail. It is evident that a rally above the 2.0 level would result in a positive break both on this chart and Chart 1. The momentum indicators tell us that the current situation is finely balanced, as the short-term KST is flat but bullish. Its intermediate counterpart is also flat, but bearish. The rising 65-week EMA is a positive sign, but this is less significant than normal, since the price action since mid-2015 has really been a trading range, where MA crossovers tend to be less reliable.

Chart 2

Finally, Chart 3 features the daily picture of the ratio, where it is possible that this relationship is in the terminal phase of tracing out a consolidation reverse head and shoulders. Once again, the more sensitive daily KST is bullish, but has essentially gone flat, not a lot of direction here! Bearing in mind the positive nature of the longer-term indicators in Chart 1, the ratio is setup for a potential upside breakout. We will have to wait and see whether it materializes of not, but what is the significance of a breakout if one does take place?

Chart 3

The significance for equities and Gold from an upside or downside breakout

First, and most obvious, the violation of a 10-year resistance trendline would suggest an extended trend where stocks out-perform Gold for many years. That does not mean that stocks would go up and Gold down, as an improvement in relative activity could mean that they both rally, Gold less so. Alternatively, it could mean that they both decline, with stocks dropping less. In this instance, experience suggests that a rising ratio is very bullish for stocks on both an absolute and relative basis. This is evident from the green shadings in Chart 4. They approximate previous advances in the ratio. A rising trend does not capture all the advances in the stock market. However, a falling one, indicated by the white unshaded areas, does. We can therefore conclude that a rising ratio tends to mean advancing stocks on both a relative and absolute basis. That means that when this RS trend is in a bear market we should be less exposed to stocks.

Chart 4

Chart 5 goes through the same exercise, but this time it’s the Gold/stock ratio. Once again, the shaded areas flag periods when this relationship is in a rising trend i.e. favoring Gold. With the notable exception of the recessionary 2008 period it would have paid to own Gold outright when the ratio was rising. Apart from that, all other periods when the ratio was falling i.e. most of the white areas, Gold experienced weakness.

Chart 5

One final observation lies in the fact that the current reading may be close to the red support trendline. However, it is also within striking distance of the 2011-17 bear market down trendline, and its 12-month MA, the higher of which is at .55. Personally, I think a breakout favoring stocks is more likely, but with the Dollar Index still in a bearish mode (Gold tends to move inversely with the Dollar), and stocks extended on the upside, its vital to keep an open mind on the situation. We may not know the direction of the breakout, but it does appear that the finely balanced current technical position is setting itself up for a big move, in one direction or the other.

Wither the tech stocks?

A couple of weeks ago I wrote an article touching on the fact that bearish sentiment revolving around the early to mid-June sell-off in technology (XLK) stocks, combined with a bullish hammer candle, argued in favor of a short-term rally or extended trading range. Single day patterns are expected to have an effect for between 5-10 session and ten days has elapsed since then. Right now, that rally is starting to look like the right shoulder of an upwards sloping head and shoulders pattern. Completion would take place with a daily close under, say $54.75, since that would take the price more decisively below the two lines and its blue 50-day MA.

Chart 7

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group of Walnut Creek or its affiliates.