Beware Gold Stocks Downside / Commodities / Gold and Silver Stocks 2019

The gold miners’ stockshave largely been consolidating high following last summer’s powerful upleg.  That resilience has left sentiment relativelybullish, with traders mostly expecting this sector to soon start surging again. But the jury is still out on whethergold stocks will be lucky enough to evade a bigger correction.  Major downside risks still abound, primarilyin gold which dominates gold-stock price trends.

The reversal in gold-stockfortunes this year has been radical. This is readily evident in their leading benchmark, the GDX VanEck VectorsGold 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 mostof the first half of 2019, with GDX down 4.4% year-to-date in early May.  Traders wanted nothing to do with goldstocks.

That sector slumpreflected a lack of enthusiasm for gold, which was down 0.9% YTD.  The gold stocks are effectively leveragedplays on gold, as their earnings really amplify changes in prevailing goldlevels.  But as May ended, some surprisingnews started sparking life back into the moribund gold realm.  Trump threatened to impose big tariffs onMexico until it stopped illegal immigration across the US southern border.

While he later stooddown, it was unprecedented to use tariffs as a hardline negotiating tactic for non-tradeissues.  So gold caught a nervoussafe-haven bid.  Over the next several weeksit rallied 5.5%, which GDX amplified by 2.8x with a 15.6% surge in thatspan.  That tracked perfectly with themajor gold stocks’ normal leverage to material gold moves of 2x to 3x, whichleads to outsized gains in gold uplegs.

By mid-June, gold wasflirting with its first breakout to new bull-market highs in 3.0 years.  Then top Fed officials collectively shiftedtheir future rate outlook from hiking to cutting, killing a years-old tighteningcycle.  That big dovish shift hammeredthe US dollar igniting huge gold-futures buying, which catapulted gold to that long-awaited bull breakout.  Traders flocked back to gold stocks to ridetheir metal’s surge higher.

That strong upside momentumbuilt on itself, with buying begetting buying as speculators and investors alikelove chasing winners.  By earlySeptember, gold had blasted another 14.3% higher in 2.5 months!  That fueled a strong 29.0% GDX surge in thatshort span, making for 2.0x upside leverage to gold.  But such fast gains left the metal and itsminers’ stocks really overbought,far above their 200-day moving averages.

I warned about that justdays earlier in our monthly newsletter.  “Goldis overextended, due for a healthy bull-market correction over the near-term.  Its technicals are way too overbought, and itssentiment 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 alternatingseries of uplegs and corrections, climbing two steps higher before falling onestep back.  Corrections are necessary tokeep bulls healthy, rebalancing sentiment after preceding uplegs.  Greed, enthusiasm, and even euphoria grow tooextreme after major uplegs.  Those needto be bled away and largely reversed to fear, apathy, and despair before thenext upleg can start powering higher.

Gold’s bull-breakoutsurge capped a larger 32.4% upleg that unfolded over 12.6 months, the biggestof 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 major76.2% 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 werecertainly due for breathers after such runs.

Indeed that’s exactlywhat happened since, as this GDX gold-stock-bull chart reveals.  Gold stocks have drifted lower on balancesince early September, largely consolidating high.  The all-important question today is whetherthey can keep grinding sideways until gold’s next major upleg gets underway, orif they still have considerable downside left. While most traders assume the former, the risks of the latter remainhigh.

Consolidations andcorrections exist on the same sentiment-rebalancing continuum, both bleeding awayexcessive greed common after major interim highs.  The speed that greed is nullified is dependenton both how far prices fall and how long that takes.  Since consolidations are much shallower, theyhave to last much longer to normalize gold-stock psychology.  Deeper corrections are more painful, doingthat faster.

Since mid-Septembersoon after these gold and gold-stock corrections started, for the most part GDXhas 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-stockresilience as a sign of strength.  Butearly high consolidations can still fail, rolling over into larger correctionslater.

Characteristics of thelatter are already evident in recent months’ gold-stock action, with majorminers carving a series of lower highs. That’s compressing GDX between two key resistance lines, the newersharply-downward-sloping correction one and the older upward-slopingbull-market-upleg one.  This will soonforce a technical breakout one way or the other, extending or killing thisrecent high consolidation.

While GDX alsoinitially saw some lower lows in this correction, they have flatlined over thepast couple months.  GDX sunk to $26.19in mid-October, and challenged that two more times hitting $26.23 on close inearly November and $26.20 in late November. But technically the worst of this gold-stock correction is still currentto mid-October, down 15.4% over 1.3 months. Interestingly that’s reasonable relative to gold.

The yellow metal’s owncorrection has retreated 6.4% at worst so far as of late November, which means GDXis 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 goldstocks should be able to continue consolidating high.  But if gold’s own correction isn’t over, furtherselling could drag the gold stocks considerably lower in coming months.

Before we get to gold, GDX’scorrection so far is very mild and brief according to its own historical standards.  Today’s correction is actually this seculargold stock bull’s third.  The first clockedin 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 similarserious 31.3% loss accruing over 19.1 months. Together they averaged 35.4% over 11.8 months.

The precedent for biggold-stock corrections runs way farther back though.  Gold stocks’ last secular bull straddling thebirth of GDX ran for 10.8 years between November 2000 to September 2011.  The older HUI NYSE Arca Gold BUGs index sectorbenchmark 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’sfirst-in-a-century stock panic which was an anomalously-extreme one, the other11 averaged 26.1% HUI losses over 2.8 months. So the current gold stock correction’s 15.4% in 1.3 months is exceedinglysmall and short by sector standards. This small contrarian sector has a reputation for being wildly volatilefor a reason.  A mere 15% correctionafter a massive 76% upleg would certainly be a first.

If you look at all 14previous corrections in these latest couple secular gold-stock bulls, everysingle one of them also had another telltale characteristic.  They all at least fell back to, and usually considerablyunder, the major gold stocks’ 200-day moving averages per the HUI and GDX.  That technical baseline is key support withinongoing bull markets.  GDX plunged farbelow its 200dma in this bull’s first two corrections.

One way to quantify GDX’slevel relative to its 200dma is by dividing this ETF’s daily closes by thatmoving average.  That forms a construct Icall the relative GDX, or rGDX.  Whenthis bull’s first correction bottomed in mid-December 2016, GDX was trading atjust 0.767x its 200dma.  At its second correction’snadir hit in mid-September 2018, the rGDX fell to 0.801x.  GDX plunged over 20%+ under its 200dmaon average!

Yet at worst so far in today’sthird 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 shallowand short-lived relative to what this sector has done in the past.  That makes me wary after long decades tradinggold stocks.

Gold stocks’ resiliencein the last couple months resulted from residual greed, because theyhaven’t sold off deep enough or long enough yet to rebalance sentiment.  That has really skewed another excellentindicator that flags major correction bottomings.  That’s the ratio between the gold stocks andthe price of gold which drives them.  Itis usually expressed as the HUI/Gold Ratio, because of that index’s longhistory.

Since the major goldstocks amplify gold’s swings by 2x to 3x, the HGR normally crests right asmajor gold uplegs are peaking.  Back onSeptember 4th as gold, the HUI, and GDX all hit their latest interim highscapping their last uplegs, the HGR ran 0.152x. As gold stocks’ leverage is a double-edged sword, it works to thedownside too.  So gold stocks look theworst relative to gold when gold corrections bottom.

That manifests itselfin low HGR reads.  Yet at gold’s most-recentcorrection low in late November, the HGR was only 0.143x.  That was much higher than the HGR’s low ebbduring this correction of 0.134x in mid-October.  And the gold stocks have well outperformedgold since, with the HGR regaining its gold-upleg-peak levels of 0.152xtwice so far in December!  That’sincredibly-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 newcorrection lows in early and late November. At some point this greed-fueled disconnect has to be resolved.  Either gold needs to rally and decisively breakout of its correction downtrend, or the gold stocks need to fall to reestablishnormal downside leverage.  Something has togive.

The ultimate arbiter ofwhat’s coming for gold stocks is what happens with gold.  If gold’s own correction has bottomed, the goldstocks will likely get away with consolidating high and not seeing major newlows before their next upleg.  Butunfortunately it looks like gold’scorrection isn’t over yet, which I explained in depth in last week’s essay.  Gold-stock speculators and investors reallyneed to pay attention to gold’s situation.

Without rehashingeverything, gold is the dominant primary driver of gold-stock fortunes.  And how gold-futures speculators arecollectively trading is the dominant primary driver of gold.  They wield outsized influence on gold pricelevels due to the extreme leverage inherent in gold-futures trading, and thefact that the resulting gold-futures price is gold’s world reference one.  Specs’ current gold-futures bets are ominous.

This updated chart superimposesgold over specs’ total long contracts in green and total shorts in red.  Gold corrections within secular bulls aredriven by spec selling, both dumping longs and adding shorts.  But so far in gold’s current correction, theyhaven’t done much of either yet!  Thusthese gold-dominating traders have vast room to sell but little room tobuy, implying gold’s own near-term downside risks remain high.

This gold bull’s firstcouple corrections following major uplegs were driven by speculatorselling.  Gold fell with spec longcontracts and new shorting, or falling green and rising red lines.  Incidentally this essential normalization ofspecs’ 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 hasmerely retreated 6.4% over 2.8 months at worst so far.  That is almost certain to grow considerably asgold-futures speculators sell down their super-high longs and ramp theirsuper-low shorts.  Both need to meanrevert back much closer to normal levels. In this latest week of reporting for spec positioning, their total longsand shorts were running 85% and 1% up into their gold-bull trading ranges.

That’s perilously closeto the most-bearish-possible-for-gold 100% longs and 0% shorts, which signals buyingexhaustion leaving nothing but potential selling.  If total spec longs’ and shorts’ gold-bulltrading ranges are considered, these traders now have room to sell 392.8kcontracts on both sides of the trade.  Thatis a staggering 10.1x larger than their room to buy of 38.9k!  Gold still faces massive potential selling.

The specific catalystdoesn’t matter, one always arises eventually when spec gold-futures positioninghits extremes.  Vast selling has to occurbefore gold is out of the woods in this correction.  Total spec longs are way up in their 98thpercentile 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 extremebets!

And mark my words, whengold is pummeled to new correction lows on heavy gold-futures selling the goldstocks will amplify those losses.  Againthe major gold stocks’ historical leverage to gold is 2x to 3x.  So if the total gold correction extends to astill-modest 10%, GDX should be down 20% to 30% from its early-Septemberpeak.  That works out to GDX $24.76 to$21.67, another 11% to 22% lower from this week!

And the potential near-termgold-stock downside could be even worse. Gold just enjoyed its biggest upleg of this bull, and corrections tendto be proportional.  So another 15%gold correction, actually just in line with this bull’s average, certainly isn’tout of the question.  If gold’s totalselloff extends to 15% again, the major gold stocks will drop 30% to 45% intotal.  That would hammer GDX down to $21.67to $17.02!

That’s a soul-crushing 22%to 39% below this week’s levels.  While Idoubt gold or the gold stocks will drop that far, their near-term downsiderisks remain considerable.  It just seemsprudent to be wary here until gold-futures speculators’ positions normalize.  Until they do, gold and thus the gold stocksface way-larger-than-normal selloff potential. These corrections won’t decisively bottom until that largely passes.

The core mission oftrading is multiplying wealth by buying low then later selling high.  Practically that means aggressively adding goldstocks late in corrections, and then ratcheting up stop losses to harvest thosebig gains late in uplegs.  Today the oddscertainly don’t favor one of those major buy-low points being upon us.  Neither the gold nor gold-stock corrections lookmature yet, indicators aren’t signaling bottomings.

To multiply your capitalin the markets, you have to trade like a contrarian.  That means buying low when few others are willing,so you can later sell high when few others can.  In the first half of 2019 well before goldstocks soared higher, we recommended buying many fundamentally-superior gold andsilver miners in our popular weekly and monthly newsletters.  We later realized big gains including 109.7%, 105.8%, and 103.0%!

To profitably trade high-potentialgold stocks, you need to stay informed about what’s driving broader gold cycles.  Our newsletters are a great way, easy to readand affordable.  They draw on my vast experience,knowledge, wisdom, and ongoing research to explain what’s going on in the markets,why, and how to trade them with specific stocks.  Subscribe today and take advantageof our 20%-off sale!  Get onboardnow so you can mirror our coming trades for gold’s next upleg after this correctionlargely passes.

The bottomline is this gold-stock correction still looks young.  This sector’s selloff so far has been both shallowand short, way milder than historical precedent.  These minor losses have failed to rebalancesentiment, leaving lots of residual greed. That still has to be eradicated, which is the reason bull-marketcorrections exist in the first place.  Themajor correction-bottoming indicators all imply more downside coming.

Ultimatelygold stocks are going to follow gold like usual, amplifying its big moves.  Gold’s own correction hasn’t run its courseeither.  Speculators’ gold-futures betsremain excessively bullish, leaving room for massive selling to normalize thosepositions.  That will likely force goldand thus its miners’ stocks considerably lower. The resulting real correction bottomings will be the major buying opbefore gold’s next bull upleg.

Adam Hamilton, CPA

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