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Gold Stock's Breakout Could Spark a Double-Digit Rally

There has been a lot of strong commentary this month about gold and gold stocks. Major firms are downgrading their outlooks while financial headlines are rife with calls that the bottom is in. Which is it?

I agree more with the latter than the former. Let's say for now that the bottom really is in. Which stocks should be on your watch list, if not already in your portfolio, to take advantage of the early rallies?

Working strictly from the technical side, this is what I want to see in a nutshell. I want stocks that have broken out on a relative basis versus the sector. In other words, I want stocks that have already shown technical strength, and therefore, greater demand from investors, even if their charts seem not quite ripe on an absolute basis. Should gold stocks as a group get moving to the upside, these "in demand" stocks should outperform.

We have to start with the sector itself and the Market Vectors Gold Miners ETF (GDX) as its proxy. It is no secret that this ETF suffered a steep bear market over the past two-plus years. The latest "proof" was a lower low set in December versus the previous major low set in June.

But there are several stocks, such as Barrick Gold (ABX), that set a major low in June but a higher low last month. This divergence between stock and sector is the first clue that the investors are starting to build buying interest -- and demand -- for its shares.

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ABX Stock Chart

As we can see in the chart, ABX is still below major resistance from several highs set last year. Therefore, a quick look will not yield much in the way of excitement on the bullish side. The best conclusion is that the stock is moving sideways, and the worst is that it is possibly coiling tighter in preparation for a new breakdown.

But with the simple rising relative performance to its sector and the sector itself moving higher for the past four weeks despite the hugely negative sentiment surrounding it, perhaps there is more here than meets the eye.

Let's zoom in a bit more. Not only did the week-to-week comparison yield a divergence between ABX and the sector but so, too, does a day-to-day comparison. GDX scored a low in early December and a lower low at month-end. ABX's late December low was higher than its earlier low, and that is another bullish price divergence.

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Finally, ABX broke out of a two-week flag pattern following a five-week rally. It is a bullish configuration, and a buy signal was triggered with a move above the flag's upper border near $18.10.

It is also above its 200-day moving average for the first time since October 2012. So while resistance from last year still looms above in the $21-area, plus or minus two bits, ABX will have the wind at its back to reach that level and also a real shot to confirm a new bullish trend.

Recommended Trade Setup:

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-- Buy ABX at the market price
-- Set stop-loss at $17.60
-- Set initial price target at $21 for a potential 12% gain in four weeks

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