The
gold miners’ stocks have largely been consolidating high following
last summer’s powerful upleg. That resilience has left sentiment
relatively bullish, with traders mostly expecting this sector to
soon start surging again. But the jury is still out on whether gold
stocks will be lucky enough to evade a bigger correction. Major
downside risks still abound, primarily in gold which dominates
gold-stock price trends.
The
reversal in gold-stock fortunes this year has been radical. This is
readily evident in their leading benchmark, the GDX VanEck Vectors
Gold Miners ETF. Comprised of the
world’s largest
gold miners, GDX is this sector’s most-popular trading vehicle.
The gold miners weren’t faring well for most of the first half of
2019, with GDX down 4.4% year-to-date in early May. Traders wanted
nothing to do with gold stocks.
That
sector slump reflected a lack of enthusiasm for gold, which was down
0.9% YTD. The gold stocks are effectively leveraged plays on
gold, as their earnings really amplify changes in prevailing
gold levels. But as May ended, some surprising news started
sparking life back into the moribund gold realm. Trump threatened
to impose big tariffs on Mexico until it stopped illegal immigration
across the US southern border.
While he later stood down, it was unprecedented to use tariffs as a
hardline negotiating tactic for non-trade issues. So gold
caught a nervous safe-haven bid. Over the next several weeks it
rallied 5.5%, which GDX amplified by 2.8x with a 15.6% surge in that
span. That tracked perfectly with the major gold stocks’ normal
leverage to material gold moves of 2x to 3x, which leads to
outsized gains in gold uplegs.
By
mid-June, gold was flirting with its first breakout to new
bull-market highs in 3.0 years. Then top Fed officials collectively
shifted their future rate outlook from hiking to cutting,
killing a years-old tightening cycle. That big dovish shift
hammered the US dollar igniting huge gold-futures buying, which
catapulted gold to that
long-awaited bull
breakout. Traders flocked back to gold stocks to ride their
metal’s surge higher.
That
strong upside momentum built on itself, with buying begetting buying
as speculators and investors alike love chasing winners. By early
September, gold had blasted another 14.3% higher in 2.5 months!
That fueled a strong 29.0% GDX surge in that short span, making for
2.0x upside leverage to gold. But such fast gains left the metal
and its miners’ stocks
really overbought,
far above their 200-day moving averages.
I
warned about that just days earlier in our monthly newsletter.
“Gold is overextended, due for a healthy bull-market correction over
the near-term. Its technicals are way too overbought, and its
sentiment way too greedy. Too many buyers have flooded in too
quickly, exhausting gold’s near-term upside potential. My best
guess is a 6%-to-12% gold selloff, which the major gold stocks will
leverage like usual by 2x to 3x.”
Bull
markets are alternating series of uplegs and corrections, climbing
two steps higher before falling one step back. Corrections are
necessary to keep bulls healthy, rebalancing sentiment after
preceding uplegs. Greed, enthusiasm, and even euphoria grow too
extreme after major uplegs. Those need to be bled away and largely
reversed to fear, apathy, and despair before the next upleg can
start powering higher.
Gold’s bull-breakout surge capped a larger 32.4% upleg that unfolded
over 12.6 months, the biggest of its 4.0-year-old secular bull so
far. That pushed gold to a mighty 6.4-year secular high! And GDX’s
strong parallel rally climaxed a major 76.2% upleg that ran
over 11.8 months. This leading sector ETF peaked at its own
3.1-year high. So both the metal and its miners’ stocks were
certainly due for breathers after such runs.
Indeed that’s exactly what happened since, as this GDX
gold-stock-bull chart reveals. Gold stocks have drifted lower on
balance since early September, largely consolidating high. The
all-important question today is whether they can keep grinding
sideways until gold’s next major upleg gets underway, or if they
still have considerable downside left. While most traders assume
the former, the risks of the latter remain high.
Consolidations and corrections exist on the same
sentiment-rebalancing continuum, both bleeding away excessive greed
common after major interim highs. The speed that greed is nullified
is dependent on both how far prices fall and how long that takes.
Since consolidations are much shallower, they have to last much
longer to normalize gold-stock psychology. Deeper corrections
are more painful, doing that faster.
Since mid-September soon after these gold and gold-stock corrections
started, for the most part GDX has meandered in a trading range
between $26 to $28. That is relatively strong compared to gold,
which is why so much residual greed remains in this sector. Traders
rightfully view that gold-stock resilience as a sign of strength.
But early high consolidations can still fail, rolling over
into larger corrections later.
Characteristics of the latter are already evident in recent months’
gold-stock action, with major miners carving a series of lower
highs. That’s compressing GDX between two key resistance lines,
the newer sharply-downward-sloping correction one and the older
upward-sloping bull-market-upleg one. This will soon force a
technical breakout one way or the other, extending or killing this
recent high consolidation.
While GDX also initially saw some lower lows in this correction,
they have flatlined over the past couple months. GDX sunk to $26.19
in mid-October, and challenged that two more times hitting $26.23 on
close in early November and $26.20 in late November. But
technically the worst of this gold-stock correction is still current
to mid-October, down 15.4% over 1.3 months. Interestingly that’s
reasonable relative to gold.
The
yellow metal’s own correction has retreated 6.4% at worst so far as
of late November, which means GDX is showing normal 2.4x downside
leverage. That’s right in the middle of that historical 2x-to-3x
range. If gold doesn’t fall any farther, the gold stocks should be
able to continue consolidating high. But if gold’s own correction
isn’t over, further selling could drag the gold stocks considerably
lower in coming months.
Before we get to gold, GDX’s correction so far is very mild and
brief according to its own historical standards. Today’s correction
is actually this secular gold stock bull’s third. The first clocked
in at 39.4% over 4.4 months in largely the second half of 2016,
utterly brutal. The second took way longer, but ended at a similar
serious 31.3% loss accruing over 19.1 months. Together they
averaged 35.4% over 11.8 months.
The
precedent for big gold-stock corrections runs way farther
back though. Gold stocks’ last secular bull straddling the birth of
GDX ran for 10.8 years between November 2000 to September 2011. The
older HUI NYSE Arca Gold BUGs index sector benchmark skyrocketed
1664.4% higher in that span! Those gains came across a dozen major
uplegs, which were naturally followed by an equal
dozen major
corrections.
Even
excluding 2008’s first-in-a-century stock panic which was an
anomalously-extreme one, the other 11 averaged 26.1% HUI losses over
2.8 months. So the current gold stock correction’s 15.4% in 1.3
months is exceedingly small and short by sector standards.
This small contrarian sector has a reputation for being wildly
volatile for a reason. A mere 15% correction after a massive 76%
upleg would certainly be a first.
If
you look at all 14 previous corrections in these latest couple
secular gold-stock bulls, every single one of them also had another
telltale characteristic. They all at least fell back to, and
usually considerably under, the major gold stocks’ 200-day moving
averages per the HUI and GDX. That technical baseline is key
support within ongoing bull markets. GDX plunged far below its
200dma in this bull’s first two corrections.
One
way to quantify GDX’s level relative to its 200dma is by dividing
this ETF’s daily closes by that moving average. That forms a
construct I call the relative GDX, or rGDX. When this bull’s first
correction bottomed in mid-December 2016, GDX was trading at just
0.767x its 200dma. At its second correction’s nadir hit in
mid-September 2018, the rGDX fell to 0.801x. GDX plunged over
20%+ under its 200dma on average!
Yet
at worst so far in today’s third bull-market correction, GDX has
merely slumped to 1.047x its 200dma. 5% above that baseline hardly
seems correction-bottoming-worthy, and if that held it would mark
another first in modern gold-stock history. This gold-stock selloff
seems way too shallow and short-lived relative to what this sector
has done in the past. That makes me wary after long decades trading
gold stocks.
Gold
stocks’ resilience in the last couple months resulted from
residual greed, because they haven’t sold off deep enough or
long enough yet to rebalance sentiment. That has really skewed
another excellent indicator that flags major correction bottomings.
That’s the ratio between the gold stocks and the price of gold which
drives them. It is usually expressed as the HUI/Gold Ratio, because
of that index’s long history.
Since the major gold stocks amplify gold’s swings by 2x to 3x, the
HGR normally crests right as major gold uplegs are peaking. Back on
September 4th as gold, the HUI, and GDX all hit their latest interim
highs capping their last uplegs, the HGR ran 0.152x. As gold
stocks’ leverage is a double-edged sword, it works to the downside
too. So gold stocks look the worst relative to gold when gold
corrections bottom.
That
manifests itself in low HGR reads. Yet at gold’s most-recent
correction low in late November, the HGR was only 0.143x. That was
much higher than the HGR’s low ebb during this correction of 0.134x
in mid-October. And the gold stocks have well outperformed gold
since, with the HGR regaining its gold-upleg-peak levels of
0.152x twice so far in December! That’s incredibly-unusual behavior
for gold stocks.
Since mid-October, gold-stock traders have been betting gold’s
correction is largely over. Yet they were wrong, as gold slumped to
new correction lows in early and late November. At some point this
greed-fueled disconnect has to be resolved. Either gold needs to
rally and decisively break out of its correction downtrend, or the
gold stocks need to fall to reestablish normal downside leverage.
Something has to give.
The
ultimate arbiter of what’s coming for gold stocks is what happens
with gold. If gold’s own correction has bottomed, the gold
stocks will likely get away with consolidating high and not seeing
major new lows before their next upleg. But unfortunately it looks
like gold’s
correction isn’t over yet, which I explained in depth in last
week’s essay. Gold-stock speculators and investors really need to
pay attention to gold’s situation.
Without rehashing everything, gold is the dominant primary driver of
gold-stock fortunes. And how gold-futures speculators are
collectively trading is the dominant primary driver of gold. They
wield outsized influence on gold price levels due to the extreme
leverage inherent in gold-futures trading, and the fact that the
resulting gold-futures price is gold’s world reference one. Specs’
current gold-futures bets are ominous.
This
updated chart superimposes gold over specs’ total long contracts in
green and total shorts in red. Gold corrections within secular
bulls are driven by spec selling, both dumping longs and adding
shorts. But so far in gold’s current correction, they haven’t done
much of either yet! Thus these gold-dominating traders have vast
room to sell but little room to buy, implying gold’s own
near-term downside risks remain high.
This
gold bull’s first couple corrections following major uplegs were
driven by speculator selling. Gold fell with spec long contracts
and new shorting, or falling green and rising red lines.
Incidentally this essential normalization of specs’ aggregate
gold-futures bets fueled far-bigger gold corrections, 17.3% over 5.3
months and 13.6% over 6.7 months. That averaged 15.5% in 6.0
months, far bigger than today’s correction.
Remember gold has merely retreated 6.4% over 2.8 months at worst so
far. That is almost certain to grow considerably as gold-futures
speculators sell down their super-high longs and ramp their
super-low shorts. Both need to mean revert back much closer
to normal levels. In this latest week of reporting for spec
positioning, their total longs and shorts were running 85% and 1% up
into their gold-bull trading ranges.
That’s perilously close to the most-bearish-possible-for-gold 100%
longs and 0% shorts, which signals buying exhaustion leaving nothing
but potential selling. If total spec longs’ and shorts’ gold-bull
trading ranges are considered, these traders now have room to sell
392.8k contracts on both sides of the trade. That is a
staggering 10.1x larger than their room to buy of 38.9k! Gold
still faces massive potential selling.
The
specific catalyst doesn’t matter, one always arises eventually when
spec gold-futures positioning hits extremes. Vast selling has to
occur before gold is out of the woods in this correction. Total
spec longs are way up in their 98th percentile of all weeks since
early 1999, while total spec shorts are just 2.1% over their recent
gold-bull-to-date lows. Big gold-futures selling is inevitable
to normalize these extreme bets!
And
mark my words, when gold is pummeled to new correction lows on heavy
gold-futures selling the gold stocks will amplify those losses.
Again the major gold stocks’ historical leverage to gold is 2x to
3x. So if the total gold correction extends to a still-modest 10%,
GDX should be down 20% to 30% from its early-September peak.
That works out to GDX $24.76 to $21.67, another 11% to 22% lower
from this week!
And
the potential near-term gold-stock downside could be even worse.
Gold just enjoyed its biggest upleg of this bull, and corrections
tend to be proportional. So another 15% gold correction,
actually just in line with this bull’s average, certainly isn’t out
of the question. If gold’s total selloff extends to 15% again, the
major gold stocks will drop 30% to 45% in total. That would hammer
GDX down to $21.67 to $17.02!
That’s a soul-crushing 22% to 39% below this week’s levels. While I
doubt gold or the gold stocks will drop that far, their near-term
downside risks remain considerable. It just seems prudent to be
wary here until gold-futures speculators’ positions normalize.
Until they do, gold and thus the gold stocks face
way-larger-than-normal selloff potential. These corrections won’t
decisively bottom until that largely passes.
The
core mission of trading is multiplying wealth by buying low then
later selling high. Practically that means aggressively adding gold
stocks late in corrections, and then ratcheting up stop losses to
harvest those big gains late in uplegs. Today the odds certainly
don’t favor one of those major buy-low points being upon us.
Neither the gold nor gold-stock corrections look mature yet,
indicators aren’t signaling bottomings.
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upleg after this correction largely passes.
The bottom line is
this gold-stock correction still looks young. This sector’s selloff
so far has been both shallow and short, way milder than historical
precedent. These minor losses have failed to rebalance sentiment,
leaving lots of residual greed. That still has to be eradicated,
which is the reason bull-market corrections exist in the first
place. The major correction-bottoming indicators all imply more
downside coming.
Ultimately gold
stocks are going to follow gold like usual, amplifying its big
moves. Gold’s own correction hasn’t run its course either.
Speculators’ gold-futures bets remain excessively bullish, leaving
room for massive selling to normalize those positions. That will
likely force gold and thus its miners’ stocks considerably lower.
The resulting real correction bottomings will be the major buying op
before gold’s next bull upleg. | 
