The price of gold is set overseas, specifically by the two London fixings each day and the international spot markets. In South Africa, our gold shares have to contend with a volatile gold price as well as all the problems of mining in this country – strike action, uncertain legislation, faulting, friability of rock, deep level mining etc.. The combination makes them extremely volatile and risky. It is very difficult to know or find out what the important factors are for any particular mining group, especially if you have little or no expertise in mining.
For these reasons, the best strategy is to focus on technical analysis and look for specific signals which may indicate that gold shares generally or a specific gold share is oversold. In our opinion, the best mechanism is the Overbought/Oversold (OB/OS) indicator in ShareFriend. This indicator shows the extent to which shareholders have over-reacted historically both on the upside and the downside. Consider the following chart:
Here you can see that we have divided the screen into to two charts. The upper chart shows the JSE gold index over the past 32 years. Recently, in the past nine months, the gold index has made three bottoms at around 1180, indicating clear support at that level.
The lower chart shows a 200-day OB/OS. This indicator is interesting because it enables the technical analyst to determine a share/index’s propensity to over-react. In the case of the JSE gold index, the propensity of investors to over-react is more – probably because of the volatile and unpredictable nature of the market. Studying the history of the OB/OS on the gold index, you can see that it occasionally reaches an oversold level of minus 35 (the horizontal red line). In fact, it has touched or gone below this level on just six occasions (the black circles) over the past 32 years – and on each of those occasions, the JSE gold index represented a good buying opportunity. The index is still very close to the level it reached at the most recent of these signals and so, statistically, it seems probable that it is still over-sold and due for an upward move.
You may also notice, looking at the lower chart, that the OB/OS very seldom goes up to a peak level above plus 65. In fact, it has done that only on 3 occasions during the last 32 years. Looking at this chart it might seem insane to think that someone actually was a buyer for gold shares at that extremely overbought level. But that must have been the case because otherwise the chart would not go to that level.
The conclusion must be that if you buy gold shares at an oversold level of -35 or lower your probability of being wrong is extremely low and you will at least have the satisfaction of knowing that you did a lot better that the guy who bought at above +65!
You must see that studying this long-term chart of the OB/OS on the gold index significantly improves your probability of making money in the volatile and unpredictable gold market.
Of course, the OB/OS can be applied to any chart and used in conjunction with other indicators.