The easy money, if there is such a thing, has already been made in the gold sector. Any immediate gains from here are going to be harder to come by.
Look at this chart of the Gold Bugs Index (HUI)…
When we looked at the gold sector three weeks ago, we noted the sector was oversold and set up for at least a short-term, snap-back rally.
That’s what we got. HUI blasted higher – gaining 16% in one week.
For the past two weeks, though, not much has happened in the gold sector. HUI has been consolidating its explosive move higher by chopping back and forth in a tight, high-level trading range.
Most traders will view that as bullish action, setting the stage for another move higher. But, from my perspective, we don’t really have much of a setup for a low-risk/high-reward trade.
Let me explain…
The 50-day moving average (the squiggly blue line on the chart) serves as a magnet for the price of HUI. Whenever the index strays too far above or below its 50-DMA, HUI tends to snap-back towards the line. And three weeks ago, when HUI was trading about 10% below its 50-DMA, we liked the setup for a rally.
Today, we have nearly the opposite condition.
If we were to buy into the gold sector here, with HUI near $233, we would be vulnerable to a decline in the index towards its 50-DMA at $219. That’s a risk of about 6%.
On the upside, the most obvious resistance level is the December high near $250. That gives us a potential reward of 7%.
So, any trade in the gold sector right now is pretty much a 50/50 proposition. Our potential gain is the same as our potential loss.
That’s not a good setup for a trader.
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We’ll have a better setup if HUI can pull back towards its 50-DMA over the next week or two. Look at what happened to HUI in December, for example. That’s when the sector put on an explosive rally, pulled back towards its 50-DMA while all of the momentum indicators at the bottom of the chart drifted down to neutral conditions, and then exploded higher again.
Similar action this time around would have HUI pull back towards 220 or so sometime this week or next. And, that would set the stage for another explosive move higher.
It’s possible that Wednesday’s FOMC announcement could provide the catalyst for a pullback in the gold sector.
Best regards and good trading,
Jeff Clark