Gold falls to a historic oversold condition

Key points:

• The Relative Strength Index (RSI) for gold futures declined to one of the lowest values in history
• Similar oversold conditions led to a rally 78% of the time over the subsequent two months
• When gold and the S&P 500 register oversold RSI conditions in unison, gold rallies 100% of the time

Price momentum in gold has gotten so bad that it's good 

Traders want nothing to do with traditionally defensive investment vehicles like Gold or Utility stocks as Treasury yields again soar to new highs, providing a more compelling option.

The intense selling pressure in gold sent the Relative Strength Index (RSI), a momentum indicator, to one of the most oversold conditions in history, a level seen less than 1% of the time since 1971.

Relative Strength Index (RSI) values below 20, like now, produce outsized annualized returns.

Similar oversold conditions led to a rally, but returns were somewhat tepid

When the Relative Strength Index (RSI) for gold falls below 20, the precious metal shows a solid tendency to rally over the next two months with a 78% win rate. However, median returns over all time horizons are not exactly compelling.

One concern with the current signal relative to history is the long-term price momentum backdrop for gold. In most cases, especially since 1975, the one and two-year return for gold was negative, providing a more washed-out market condition that made a mean revision bounce compelling.

With the 10-year yield at the upper end of its one- and two-year range and the yield curve inverted, some historical precedents are similar to now, suggesting gold can rally.

Gold and stocks are oversold

For only the 11th time in history, the Relative Strength Index (RSI) for gold and the S&P 500 fell below a reading of 30 on the same day.

When gold and stocks are oversold, the precious metal is higher two months later every time. The median return of 24% over the subsequent six months is outstanding.

There are plenty of analogs similar to the current environment, whether gold returns, the 10-year yield range, inverted yield curve, rate hikes, or market type. In all cases, gold was higher two months later. Will this time be different?

The outlook for stocks after gold and the S&P 500 register an oversold condition

While the outlook for the S&P 500 looks okay, most of the signals occurred in the 1966-82 secular bear market, a period more similar to the current environment regarding inflation and Federal Reserve policy.

A relative comparison between gold and the S&P 500 suggests the precious metal could outperform the world's most benchmarked index over the next six months.

What the research tells us...

Like other defensive vehicles, gold has been under severe pressure, with interest rates rising to new highs. The downside momentum in the commodity has caused the Relative Strength Index (RSI) to plummet to levels rarely seen in history, often foreshadowing the start of a multi-month mean-reversion rally. The oversold condition in gold was also accompanied by one in the S&P 500. Following similar signals, gold rallied 100% of the time over the subsequent two months, consistently outperforming the world's most widely benchmarked index.

Oversold conditions are a precondition. It is crucial to utilize a trend filter or another type of indicator to determine the optimal time to initiate a position.