Based on the August 30th, 2013 Premium Update. Visit our archives for more gold articles.

Yesterday, gold stopped a five-day rally that had pushed it to its highest since mid-May, and lost some of its safe-haven appeal as the chance of imminent U.S. military strikes against Syria seemed to diminish, and investors booked profits. We let our subscribers know our thoughts on that topic and we wrote that we didn’t expect any military intervention in the next few days and it seemed to us that markets had overestimated the probability of such intervention taking place in the near term.

Today, the yellow metal extended its decline and dropped below $1,400 per ounce as the probability of an immediate U.S. strike on Syria faded, and strong U.S. data rekindled fears of an imminent scale-back of the Federal Reserve's stimulus measures.

Taking the above into account, the big question is: would it be the metal's final increase in the near term? In our essay on mining stocks and the dollar we examined the US Dollar Index, the HUI Index and the gold stocks:gold ratio to check their implications for gold.

As is well known, if you want to be an effective and profitable investor, you should look at the situation from different perspectives and make sure that the actions that you are about to take are really justified. That’s why in today’s essay we examine the stock market and the mining stocks (along with their performance relative to gold) to see if there’s anything on the horizon that could drive gold prices higher or lower. We’ll start with the S&P 500 Index long-term chart (charts courtesy by http://stockcharts.com.)

On the above chart, we see that the situation hasn’t changed much since last week.

As we wrote in our essay on gold, stocks and the dollar on August 23,2013:

The correction is still shallow from the long-term perspective, and the S&P 500 Index reached the rising support line based on the November 2012 January 2013 lows (in terms of weekly closing prices).

Please note that there is another rising support line based on the November 2012 -January 2013 lows (on an intraday basis), which may stop a correction even if the current support doesn’t hold. Therefore, the downside seems limited.

As you see on the above chart, we witnessed this type of price action in the past week. Technically, the outlook for the S&P 500 index hasn’t changed. It remains bullish.

Before we examine the Broker-Dealer Index chart to see what the financial sector is doing, let’s take a look at the DIA ETF chart, which is another proxy for the general stock market.

Quoting from our essay on gold, stocks and the dollar on August 23,2013

(…) the DIA ETF moved lower, and the RSI based on it moved below 30 - almost to the 26 level. Since the beginning of 2008, there have been exactly 7 cases when we saw something similar. In 4 of them, this meant that an important bottom had just been formed. In the remaining 3 cases, a major bottom was formed in a short time anyway.

Although we didn’t see this signal have an impact in the past week, it is still in play and can lead to a bigger pullback or – more likely – a new upleg. It seems that the bottom might already be in.

We now turn to the financial sector, which in the past used to lead the rest of the general stock market, to see whether the above is confirmed or invalidated.

It’s confirmed. On the above chart, we see that there was another downward move which took the financials to the previously broken resistance level of 130. Despite this fact, the financials still remain above the 130 level, which also corresponds to the 2011 top.

The breakout above the level of 130 has not been invalidated, and this confirms that nothing has changed. We can still expect further growth in the financial sector and the general stock market.

What are the implications for gold? Gold and stocks have been negatively correlated in August and it seems that a considerable part of gold’s gains can be attributed to a decline in the stock market. Consequently, the bullish outlook for stocks is likely to have a negative impact on gold.

Once we know what the current situation in the stock market is, let’s move on to the XAU Index and try to find out what kind of impact the mining stocks can have on gold’s future price.

On the above XAU Index chart, we see that our previous target area (marked with a red ellipse) was reached in June. The strong rising support line based on the 2000 and 2008 bottoms seems to have encouraged buyers to act, and we can see that mining stocks pulled back to the previously-broken 61.8% Fibonacci retracement level – without a move above it.

As you see on the above chart, this resistance level slowed further growth and mining stocks declined in recent days. From this perspective, it seems that the next move lower will take the XAU Index to the bottom of the previous corrective move. However, if it is broken, the next downside target for the sellers will be around the 2008 low or even below it.

Before we summarize, let’s turn to our final chart - the gold stocks:gold ratio. After all, gold stocks used to lead gold both higher and lower for years (not in the very recent past, though).

On the above chart, we see that last week there was a verification of the breakdown below the 2008 low. Although the ratio reached its 2008 low, it slipped below it once again in the following days. Earlier this week, we saw a significant decline which took the ratio to the 0.180 level. With this move, the gold stocks:gold ratio dropped below the 50-day moving average, which now serves as resistance.

From this point of view, the trend remains down, and the recent rally was nothing more than a verification of a major breakdown. The above picture remains bearish.

Summing up, the situation in the stock market suggests that the next move in stocks will be to the upside, which means that a move to the downside will likely be seen in case of the precious metals sector. Additionally, the long-term bearish tendencies in mining stocks seem most important at this time, even for short-term price moves. The breakdown below the April low was invalidated and the move above the 61.8% Fibonacci retracement failed once again. The long-term trend in the gold stocks:gold ratio remains down, and a major breakdown seems to have just been verified.

If you're wondering what's the best way to profit on the current decline in the precious metals sector (it seems that there's a better way to do it than to short all sectors at the same time), we suggest reading today's Premium Update. It's one of the many issues that we covered in it.

Thank you for reading. Have a great weekend and profitable week!

Przemyslaw Radomski, CFA