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Gold stocks could help "call the market."

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The recent "weakness" in gold stocks has concerned some bulls in the sector that have been banking on this sector calling the demise for the broader markets here in the U.S. and around the world. For years, "gold bugs" as they are affectionately called have been saying that gold stocks were due to rally and that the pending collapse of many stock markets and financial institutions around the world would suffer and that "gold bugs" would prosper.

Until the past six months, those warnings from gold bugs fell on deaf ears, but lately that has changed.

But, as many have come to understand, its usually after a young bull has watched a sector surge higher that he/she eventually gets the gumption to step in and get some bullish exposure to the sector, despite its strong run.

Last week, we did see some rather "suspicious" selling in the group. Suspicious in that it came under broader market declines despite still looming threats of war in the Middle East.

There are some near-term supply/demand shifts taking place that traders and investors may want to monitor and it may indeed help "call the market" going forward.

Every trader can use the "scenario" that gold stocks will rise and broader markets will fall. That's DIVERGENCE and something a trader always looks for.

Gold/Silver Index Chart - $2 box

The $2 box of the Gold/Silver Index (XAU.X) is used by institutions to monitor supply/demand for stocks in this group. The $2 box removes a lot of the volatility that this sector will exhibit, even though it trades below the 100 mark. This $2 box gives the trader/investor the "bigger picture" of longer-term supply/demand.

Yesterday in the market monitor, I profiled a bullish trade in shares of Newmont Mining (NYSE:NEM) $28.86 -0.48% at the $28.19 level. A trader of NEM can monitor that stock against the above chart, understanding perhaps that a trade at 72 in the XAU.X would be sign of further weakness in the sector at what looks to be a longer-term pivot point for this index dating clear back to the 72 level in November of 2000. The thinking here is that 72 was resistance back then, and may now serve as support.

One near-term negative on the $2 box of the XAU.X is the formation of a "high pole warning" where the current column of O (supply) has covered a long column of X (demand) by more than 50%. This can be an early sign that supply may be outstripping current demand for stocks in this group. This should be monitored and understood.

However, based on the bullish vertical count of $106, trades at current levels using $72 as a stop, are looking at a very favorable risk/reward trade from the bullish side. Thus a bullish profile in sector bellwether Newmont Mining (NEM) yesterday.

Gold/Silver Index Chart - $1 box

Yesterday, the Gold/Silver Index (XAU.X) achieved and slightly exceeded a bearish vertical count from its $1 box of $76. However, the test of the bullish trend made for a nice risk/reward entry point for a bullish trade, with stop set tight at $73.

Yesterday, we also talked about how a sector trader can perhaps use the smaller capitalized and often "speculative" gold stocks like Bema Gold (AMEX:BGO) $1.28 +0.78% to get a feel for how aggressive sector participants are. With BGO recovering from the $1.00 level yesterday, we perceived near-term "aggressiveness" from bulls, once again hinting of a decent bullish near-term entry point for "gold bugs."

Now all we have to do is monitor things going forward. Near- term, I'd look for some resistance in BGO at the $1.47 level, which is outlined from retracement. Funny, but this morning's low for BGO was $1.15, a penny below our 38.2% retracement support of $1.16.

We can perhaps correlated the BGO $1.47 level with the XAU.X $82.

True.. I haven't mentioned Newmont's (NEM) chart once. I don't think I necessarily have to. After all, that trade was simply set up by the action in BGO and the XAU.X levels and action outlined above. Some call it "trading in 3-dimensions" whereby the trade is initiated from other observations based on broader sector analysis and scenarios.

Stop on Newmont (NEM) $29.01 +0.06% remains just below yesterday's low of $27.61, with a near-term target of $30.

As it relates to the broader market. Gold stocks have indeed benefited at the expense of the broader market. That's some DIVERGENCE and we "know" the various reasons of why this may be. Going forward, all we have to do is monitor things.

If the XAU.X starts finding some resistance at/near the $83 level and the broader market begins to firm, be on the lookout for any weakness in gold stocks and strengthening in the broader markets.

However, should we see gold stocks continue to march higher and break to new highs, a "gold bug's" scenario for doom and gloom is still in play.

Of course, I'll also be monitoring Treasury YIELDS. I've run way late with this update, but something I feel very good and important that we can all follow to keep a pulse on things.

Jeff Bailey
Senior Market Technician
Option Investor

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