Major bottoms in any market or sector usually produce big rebounds and big
gains for those who are correctly positioned. For some, the initial strong
gains create trepidation that the market will experience a big correction or
revert back to the previous bear market (which created the foundation for the
big rebound). I've noticed this trepidation over the past few days from subscribers
and other advisors preaching caution or hedging their recent gains. This is
all well and fine but the evidence as well as history suggest not to worry
because the gains will continue unabated over the intermediate term.
I looked at history to identify the nature of corrections in gold stocks during
cyclical bull markets within secular bull markets. I looked at the major bottoms
during 1960-1980 (using the Barron's Gold Mining Index) as well as the major
bottoms during this bull market (using the HUI Gold Bugs Index) which began
in 2000. Essentially I examine how long it took for gold stocks to encounter
their first major correction (more than 21%) following a major bottom. The
column Worst D refers to the market's worst correction before the first major
correction. I found that these initial corrections were limited to 15% to 21%.
The first major correction averaged about 30% and occurred at least one year
after the major bottom.
The HUI did correct 26% in November 2008 as it retested the October low. We
left that out as it occurred instantly after the major bottom.
Look at what happened after the major bottoms of 1960, 1976, 2000 and 2008.
If we take the median of those four rebounds then it equates to the market
rebounding 251% over one year and nine months before incurring more than a
21% correction.
The only outlier is the 1969 bottom where the market corrected 35% in 1971
and then 23% in 1972 before the market exploded to the upside over the next
two years. However, following the 1969 bottom the market did rebound 83% over
one year and four months with no more than a 17% correction. It wasn't that
much of an outlier.
The lack of a big correction following a major bottom is quite common in all
equity markets. Consider how the stock market performed following the 2002
and 2009 bottoms. From October 2002 to January 2004 (16 months) the Nasdaq
rallied 93%. Its worst correction was 14%. Following the 2009 bottom, the Nasdaq
rallied 99% in 13 months! Its worst correction was 8%.
History suggests that we need not worry about a major correction anytime soon.
The HUI is currently up 30% in two months. If it's up 200% in 17 months then
it would be time to worry about a significant retracement. In the meantime,
we don't foresee any shift in the trend until the gold stocks reach the neckline
resistance (GDX $30, GDXJ $51) discussed
in our last editorial. From those levels we could get a 15% correction.
The chart below plots the average of the rebounds in the 1970s as well as
the average of the rebounds in the past decade. The current rebound (blue)
remains on track according to history.
After a major rebound its natural to want to be cautious and safe. Our emotions
react to the recent past. That is why the herd is always too bullish at market
tops and way too conservative at market bottoms. Moreover, advisors want to
play it safe by hedging their opinions and bets. Everyone is worried subconsciously
that the fledgling bull market isn't real and may revert back to a bear market.
In this instance, the hardest thing to do is be a raging bull and to buy something
that you could have bought 50% cheaper a month or two months ago. Our work
leads us to believe that we'll experience continued gains over the coming weeks
and months. For now, corrections will be brief. Use them as opportunities.
Don't overthink it. Be long, sit tight and have an exit strategy (mental stop
loss) in case things play out differently.
Good Luck!
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