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After its rather ugly
initial week of 2007, the HUI unhedged gold-stock
index has started to recover in the past week. Not surprisingly, this has created a
kind of psychological whipsawing for gold-stock traders wondering what is coming
next. Did we just witness a minor
pullback within an upleg or are we now seeing a
bear rally within a correction?
As I outlined in my essay
last week, my bet is on the former thesis. Technically the HUI, and its primary
driver gold, are carving higher highs and higher lows since early
October. In addition to this,
some powerful technical indicators are lining up
into the same positions where they have been early on in past major uplegs. The evidence
is growing suggesting the HUI is in a young upleg
and the recent carnage was merely a minor pullback.
Nevertheless, as a student
of the markets I am always seeking more information. Even in best-case scenarios, there is
always a probability that analyses that have worked for past uplegs will prove wrong this time around. The markets can be capricious and
fickle, but the better we understand them the less likely we will be caught
totally unaware by some lower-probability move.
One way to better understand
the markets and prepare for their vagaries is to illuminate them from additional
analytical perspectives. Imagine
a price is like an artifact in a museum sitting in
a display case on top of a waist-high column. If you have only one spotlight on the artifact, you can see quite a bit of it but some detail
is lost in the shadows. But if
you add more spotlights illuminating it from different angles, you can see it
even better.
The equivalent to adding
spotlights in the markets is considering a given price through additional
analytical approaches. Last week I looked at
gold and the HUI using some moving-average-based technical tools I have
developed, a couple spotlights. This
week I would like to add another spotlight coming in from a totally different
angle, a look at HUI volume. It
will help flesh out our overall HUI understanding today.
Trading-volume data for the
HUI is not readily available. If
you pull up a HUI chart in any chart service, there will be no volume charted
because the HUI itself does not actually trade. To the best of my knowledge there are
no HUI ETFs and no HUI futures. Like many indexes, its sole purpose
for existence is simply to track a basket of underlying stocks. Traders buy and sell shares in its
component stocks, but they can’t trade the index itself.
Several years ago though a
gentleman graciously wrote in and clued me in to the secret of analyzing HUI
volume. Although the HUI itself
has none, its 15 component stocks all have their own individual volumes. So all we have to do to get a
rock-solid proxy for HUI volume is add up the individual daily volumes of its
components. The result is HUI composite volume, which I wrote
an initial essay about and have discussed periodically since.
With composite volume data
available to analyze, conventional volume analysis can be performed on the
HUI. And the HUI, of course, is
probably the best proxy for the gold-mining sector as a whole. So switching on the volume spotlight
to better illuminate the HUI should give us an even better idea of where it
is likely heading in the months ahead.
But as far as technical
indicators go, volume is rather peculiar. Many technical indicators have clear
long and short states at the opposite ends of their spectrums that are
mutually exclusive. For example,
when the Relative HUI is low as it is
today, it means traders have a much higher probability of winning if they bet
on the long side. And when this
same rHUI is high, the odds favor
a coming correction so neutrality or short trades have the best chances for
success.
Volume doesn’t follow
this typical convention. Volume
ramps up when people get excited and
want to trade more. But since
there are two opposing emotions that generate excitement in the markets,
greed and fear, volume can spike to great heights when either of these emotions dominates. High volume is seen near both major interim tops, the times to
be neutral, and sharp selling panics following tops, the times to be bullish.
Because both greed and fear
can drive high trading volumes, big volume spikes must be considered within
their recent price context to decide whether they are bullish or
bearish. If prices have been
rising for months in an apparent upleg, a big
volume spike is probably signaling a top. But if prices have been plummeting for
days and panic is setting in, a similar big volume spike is probably signaling a bottom.
Context matters here.
While high volume spikes
have a dual binary nature depending on whether they were greed- or fear-driven,
thankfully low volume only signals one thing. Low-volume episodes are only witnessed
when traders are complacent, bored, discouraged, apathetic, and generally not
very excited. This typically
happens near major interim lows and later in long consolidations. Low volume signals the absence of
meaningful levels of greed and fear.
With this in mind,
let’s dive into this first chart of raw HUI composite volume over our
fantastic gold-stock bull to date.
This volume data is considered raw because it is simply the daily
totals of the 15 HUI component stocks’ individual daily share-trading
volumes added together. There is
no smoothing in this chart either, such as through moving averages.
The most immediately
striking thing about this chart is the tremendous
growth in HUI volume over the past 6+ years of this powerful bull
market. In November 2000, the month
the HUI hit its secular bottom, on one day the total volume of all the HUI
component companies was a measly 2.3m shares. Yet by May 2006, the month the HUI
achieved its latest secular top, one day witnessed a staggering 99.4m shares
of composite volume!
This trough-to-peak growth
rate is nothing less than phenomenal.
We are talking about a 4,200% gain in daily trading volume in the raw
number of HUI component shares in less than six years! To put this into perspective, the HUI
itself is “only” up 996% over this same period of time. If you have ever doubted that
participation in gold stocks is getting wider as this bull matures, this
chart should kill those fears instantly.
Another thing to bear in
mind is that this gargantuan volume increase actually massively understates the capital involved in
this sector. Just as trading
volume was rising, average share prices were also getting higher
simultaneously. An average HUI
share traded on November 2000’s 2.3m share day had a share price of
just $4.21. Multiplying these
numbers together yields a capital
volume level of just $9.7m. Talk
about an unloved sector!
Meanwhile on May
2006’s stellar 99.4m share day, the average HUI component share price
was $21.68. This yields total
capital volume on that day of $2,155m.
So in daily capital-volume terms from trough to peak, the HUI gold
stocks have exploded up by 22,100% or so! Interest in and participation in the
HUI is really deepening and growing broader as it marches higher. This is typical of all long-term bull
markets, the longer they run the more people want to buy in.
Lest you wonder if such a
crazy increase means the gold-stock bull must be ending, I wouldn’t
worry at all about that. Even at
today’s levels this entire sector is trivial in size. The total market capitalizations of all
the HUI stocks, as of the end of 2006, were only running at $91,794m. This compares to $304,840m or so for
Microsoft alone. During the last
90 trading days, MSFT’s daily capital volume averaged $1,804m, so the HUI is still very small relatively even
on its biggest volume day in history.
Back to the chart above,
the extremes in raw HUI composite volume are forming an enormous ascending
and opening wedge. I drew a
couple lines in this chart that capture most of these extreme raw volume
days. The lower one is the HUI’s volume support line and the upper is its
massive-upleg resistance line. I don’t think we should read too
much into these volume technical boundaries, but they are interesting
nevertheless.
On the lower secular
support side of this wedge, raw HUI volume has hit this support line many
times. While there are
occasionally short spikes lower to support lasting just a day or a few, the
big clusters of persistent HUI volume support approaches are far more relevant. In most cases, when HUI volume is
consistently low and near support, it happens near major interim bottoms or
late in long consolidations.
This makes sense. If the HUI has been grinding lower or
sideways for months on end, traders are getting discouraged. Some are bored, others are apathetic,
and still others are concerned. All
of these emotions add up to a low-excitement environment. Nothing saps excitement like
consistently flat or falling prices.
The HUI volume dries up during such times. This knowledge of when HUI volume is
typically near support is very useful to traders.
Over the long term, it is
underlying fundamentals that drive prices. But over the short term all that
matters is sentiment. If traders
are greedy they will bid up prices regardless of fundamentals,
and if they are scared they will sell and drive prices lower regardless of
fundamentals. But when they are
neither, when excitement wanes and volume dries up, odds are a psychological
turning point is near. Periods of
low excitement are followed by periods of high excitement, which usually
means new uplegs launching from the sentiment
ashes.
Thus low HUI volume is a
good indicator that traders are done selling. The ones who wanted to sell have sold
and the ones remaining in the game are just not excited following the poor
price action in the preceding months.
As all contrarians know, the best time to go long is when few others
want to. This occurs deep in
corrections and consolidations when boredom, apathy, and concern reign and
few want to trade.
On the top end of this HUI
volume formation, near resistance, the trading cues spawned by volume spikes
are not as clear but they are still useful to consider. Since high volume corresponds with
high excitement, and high excitement can be driven by either greed or fear,
high volume can be seen both near tops and near sharp selloffs. I found it interesting that the upper
resistance line is defined by volume tops spawned near the ends of massive uplegs.
So far in this HUI bull
market, it has advanced in an interesting alternating pattern. The first part of this pattern is an
enormous upleg that I call a “massive upleg”.
It drives the HUI up to incredible new bull-to-date highs in huge runs
averaging 136% per upleg in this bull market. The massive upleg
tops are labeled above as 2, 4, and 6. They really pushed the envelopes in
traders’ minds of what this bull is truly capable of.
But after massive uplegs, it seems like the markets are not quite sure
about the new highs just achieved.
It takes a considerable period of time for traders to accept levels as
a new base that once seemed fantastically high. This has manifested itself in the form
of uplegs after massive uplegs
being much smaller. These “consolidation
uplegs” have averaged gains of just 53% in
this bull. Examples above are 3
and 5.
If you are interested in
learning more about this massive-consolidation alternating upleg pattern, I’ve written about it in some depth in the past. Like all patterns though, this one
could fail at anytime. Since we
are now in the much more powerful Stage Two of this gold bull, I could
see the next upleg achieving new highs and breaking
the consolidation expectations. But
just as easily it could be another smaller consolidation upleg. Right now I am handicapping the odds
of this new upleg being massive or consolidation at
50/50.
Although a whole separate
issue, the massive uplegs tie into this volume
analysis because it is near their tops when HUI composite volume has spiked
to its upper resistance line rendered above. In massive uplegs
2, 4, and 6, the extreme high HUI volume spikes grew in a pretty linear
fashion. If this pattern holds into
the future, we should see a 130m+ share composite HUI volume day near the top
of the next massive upleg, whether that proves to
be today’s young upleg or the next one after.
One last observation on
this first chart is pretty interesting.
If you look at the center of mass of the
wild red volume line over the last quarter or so, it is generally in the
lower third of the big ascending wedge.
If you look back through the history of this wedge, you will note that
HUI volume tends to linger in that lower third in the early months of major
new uplegs.
We saw this in massive uplegs 2, 4, and
6. So from this perspective,
today’s HUI volume levels are right in line with the young-new-upleg thesis.
One problem with raw volume
data is it is incredibly volatile and erratic. It is not all that rare to see a high
volume day followed by a low volume day, which drives the volume line all
over the chart. This creates the
low signal-to-noise ratio you can see in the chart above. There is a lot of visual noise to weed
out in order to determine the underlying volume trends. Thankfully this wild data can be
smoothed via a moving average.
While I’ve looked at
different moving averages over the years to smooth volume, my favorite is the five-day moving average. It averages daily trading volumes over
the past week’s worth of trading days. This degree of smoothing is subtle
enough so volume extremes still match up well with the bigger moves in prices
that spawned them. Yet it is also
strong enough to yield a far-better-defined visual trend to follow.
When the 5dma filter is
applied, the HUI volume extremes become more tame
and generally fall within the linear uptrend rendered above. HUI volume sometimes drifts below the
effective support line when excitement is low and trading dries up like
during the long 2004-2005 consolidation.
And HUI volume can spike above its effective resistance when
excitement is high and trading explodes like near the HUI’s
last major interim top in May. But
for the most part, the 5dma of composite HUI volume remains in this uptrend
channel.
Just as with the raw data,
high-volume spikes represent either extreme greed- or fear-driven excitement
while low-volume spikes represent apathy and other non-excited emotions. With the higher signal-to-noise ratio
of this chart, it is easier to see that volume tends to be high near major
interim tops and low near major interim bottoms. This pattern holds perfectly
throughout the HUI’s entire bull to date.
For our purposes today, I
am most interested in the far right portion of this chart, the area between
May’s HUI top and today. Soon
after this May top, the expected selling materialized
and fear gripped the hearts of gold-stock traders as the selling
intensified. With the HUI in a
virtual freefall, selling triggered ever more selling which culminated in the
staggering 99m share day discussed above. High fear drove very high trading volumes.
But soon the HUI bounced in
June and rapidly headed up towards 350 again. This was a dangerous time as I warned
our newsletter subscribers all summer because the HUI’s
correction wasn’t yet mature which meant more downside was highly
probable. Yet complacency reigned
in a kind of no-mans’-land between greed and fear so the HUI volume
5dma meandered back down near support.
When September’s sharp slide lower shattered this complacency,
fear skyrocketed driving another huge volume spike above resistance.
But this September spike,
on pretty intense fear, turned out to be a bottoming-type event. This makes sense in context. While the sharp HUI plunge in May and
June was right after a top, way too
early in a correction for sentiment to be properly rebalanced, by September
the correction was maturing. A
fear-driven volume spike late in a
correction is a much better candidate to herald an interim bottom. And indeed this bottom came in early
October.
Since then the HUI volume
5dma has generally been gradually rising, although it trickled off
dramatically late last year as trading dried up on HUI weakness in December
as well as the usual trading distractions of the holiday season. But then as soon as trading opened in
2007 after an unforeseen delay, the HUI sold off hard along with gold and
other commodities. Fear ramped up
incredibly quickly and drove a big volume spike above resistance yet again.
Now as always with volume
analysis, the key here is the context surrounding this latest spike. The HUI had been climbing higher for a
couple months in what looked like a new upleg, but
this young upleg neither went high enough nor
lasted long enough to be considered mature. Even if it is merely a consolidation upleg, it should still at least challenge its old May
highs before it gives up its ghost.
It didn’t even come close before it started sliding in December.
One key characteristic of
young uplegs is that few folks believe in them
initially, skepticism still remains high from the
preceding correction. So a
fear-driven volume spike just a few months into a new upleg
before it has matured or approached an old high has a much higher probability
of coinciding with a healthy pullback than a correction-type event. During corrections, as you can see
above, volume tends to fade, not spike.
It doesn’t typically spike unless there is a climax selloff at the correction’s end.
While volume analysis is fairly
technical and subjective compared to other indicators, it still helps offer
an additional spotlight of illumination on a price. In the case of gold stocks, the volume
picture rendered above seems much more consistent with the early months of a
major new upleg than with the late months deep in a
correction. Only time will tell
if this interpretation is right, but I suspect it is given other indicators’
corroborating messages.
At Zeal we have been
aggressively buying gold stocks this year to exploit these fear-laden lows
that should not last. We recently
published a detailed fundamental research report on our favorite
junior gold stocks and we are actively buying some of these as well as more
conservative gold stocks in our newsletters. It is not too late to subscribe to our acclaimed
monthly newsletter today if you want to add
high-potential gold-stock positions near these apparent lows. What a wonderful opportunity!
As an added bonus, our
subscribers have exclusive access to a private charts area on our website
that includes high-resolution versions of these HUI volume charts that we
update weekly. We also update
many dozens of other unique and difficult-to-make charts that we use to aid
our own trading decisions. Our
subscribers can see all of them anytime on our website.
The bottom line is the
composite HUI volume signature we’ve seen in the last six weeks or so
is much more congruent with a young new upleg than
an old and not-yet-finished correction.
The high levels of fear seen in recent weeks are more consistent with
the wall of worries that all new uplegs must
climb. In mature corrections
prices have been grinding sideways to lower for so long that few care anymore
and volume just dries up.
While volume analysis is
not as straightforward as other technical indicators since both greed and
fear can drive high-volume events, it still offers another useful perspective
through which to illuminate price action. The more we understand the HUI or
indeed any price, the higher the odds our trades will prove correct and
successful.
Adam Hamilton, CPA
Zealllc.com
January
19, 2007
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