I went to cash the other week as the broad market corrected in response to rising bond yields and caused gold stocks to break their May lows. Towards the end of last week though the XAU and HUI bounced back up near their intermediate-term resistance levels. Last week's commitment of traders report also shows that commercial traders closed 10,659 short contracts and opened 27,732 new long contracts to lower their net short position to less than 100,000 contracts. This is by far the smallest net short position they've had all year and makes me wonder if I simply got shaken out when I sold.

I'm not sure. Right now I'm in cash and am waiting for a good safe entry point on the long side - whether that would be for a trade or for a long-term hold would depend on how things evolve from here. Let's take a look at how gold stocks stand right now:

First let's look at the long-term picture. The XAU and HUI have both been moving within a wide trading range for over a year. The 200-day bollinger bands on the XAU mark the long-term support and resistance levels of this range. For the past six months I've been anticipating a move to the upside of this range that would signal the start of a new bull market.

That signal would be comprised of three components when it comes to the XAU:

1)A break in the XAU/gold relative strength ratio to the upside. During bull runs gold stocks tend to outperform the metal and each bull run has begun when eight month plus downtrend resistance lines in the XAU and HUI have been broken.

2)A breakout of the downtrend resistance line on the XAU going back to the May high of last - currently sitting at 145. This break should lead to a fast rally up to the 150 level and cause the XAU/gld ratio to jump. It would be a power thrust up to 150, which would hint that the 150 level will ultimately be broken.

3)A move in the XAU and HUI above their 200-day bollinger bands. This is currently around 150 on the XAU. If the XAU and HUI were to stay above these levels for three weeks the breakout would be complete.

Back in the beginning of May I wrote an article that was published on leading gold websites titled "Gold Bears Have Two Weeks to Live" in which I went over these three components. The title of the article referred to the fact that I thought we would see gold stocks break to the upside within two weeks of my article. Instead gold stocks went up and made a fake breakout and then came down, keeping the bears alive in the market. Two weeks ago the XAU actually fell back down towards it support trendline, creating a risk of a large correction if it were to close below that level.

That risk is still there. There are some things that trouble me about gold stocks right now. They have been lagging the rest of the stock market and other commodity sectors. The major oil stock indices all made new highs last week and so did the industrial metals sector. In the past few months each time these sectors have corrected gold stocks have fallen harder then these sectors and when they go up gold stocks go up less. Gold stocks are in fact one of the worst performing sectors in the stock market right now. At some point this will change, but as long as it continues there is a risk that gold stocks will break to the downside and enter a short lived mini-bear market if the rest of the stock market were to undergo a correction. Things are even more uncertain now as the other commodity sectors are once again overextended.

This means that is very important right now for gold stocks to hold their recent lows. A close in the XAU and HUI below these levels would be very troubling and would put off any bull run in gold stocks by several months. The next support level for the XAU below 135 is 125. And a move down to that level would mostly likely bring a bounce and then further selling.

However, last week the XAU/gld ratio did break to the upside. I would like to see confirmation though in the HUI and more importantly in the GDX gold stock ETF, which is more broadly representative of the sector than the HUI and XAU, which has been helped out a lot by copper giant Freeport-McMoran(FCX).

The message right now is mixed. When it comes to the three components of an XAU long-term buy signal one has happened, while the two others have not, but there are some clues to be gleamed by looking at shorter-term charts of the XAU and HUI and by going through the individual gold stocks themselves.

Article continues here: WSW Power Investor Market Monitor: A Close Look at Indvidual Gold Stocks - Mike Swanson (6/18/07).