Gold: High Time to Move Out of the Penthouse / Commodities / Gold and Silver 2021
Gold’s days in a glamorous apartmentat the top of the PMs’ building are numbered. We’d better prepare for a rapidelevator ride to the first floor.
TheGold Miners
With the gold miners essentially runninglaps on the treadmill, the HUIIndex, the GDX ETF, and the GDXJ ETF are working extremely hard but makinglittle progress. And with the gambit resulting in ‘one step forward, two steps back,’ frustrating exhaustion has mining stocks questioning theirevery move. To that point, even though the trio transitioned from the conveyorbelt to the stairs in recent weeks, history shows that slow climbs oftenculminate with elevator rides lower. Should we expect a different outcome thistime around?
Goldended the week in the green (up by $27.30), but the HUI Index was stuck in thered (down by 1.39). This is extremely noteworthy, as a similar divergenceoccurred at the end of May. For context, when the yellow metal rallied by $28.60in a week back then, the HUI Index fell by 1.37 index points.
In the following weeks, the HUI Indexdeclined by about 50 index points, while gold declined by about $150.
And with the ominous imbalance precedingthe pair’s precipitous declines, again, should we expect a different outcome this time around?
Please see below:
To explain, with the HUI Index unable tomuster any meaningful relief rallies, I warned that the recent plunge was weeksin the making:
Iwrote the following about the week beginning on May 24:
Whathappened three weeks ago was that goldrallied by almost $30 ($28.60) and at the same time, the HUI – a flagship proxyfor the gold stocks… Declined by 1.37. In other words, gold stocks completelyignored gold’s gains. That showsexceptional weakness on the weekly basis and is a very bearish sign for thefollowing weeks.
To that point, with the HUI Index’sominous signals only increasing, if history rhymes (as it tends to), medium-termsupport will likely materialize in the 100-to-150 range. For context, high-end2020 support implies a move back to 150, while low-end 2015 support implies amove back to 100. And yes, it could really happen, even though such predictions seem unthinkable.
Furthermore, with the junior miners oftensuffering the most during medium-term drawdowns, short positions in the GDXJETF will likely offer the best risk-reward ratio. For context, if you held firmin 2008 and 2013 and maintained your short positions, you almost certainlyrealized substantial profits. And while there are instances when it’s wise toexit one’s short positions, the prospect of missing out on the forthcomingslide makes it quite risky.
Even more bearish, a drasticunderperformance by the HUI Index also preceded the bloodbath in 2008. Toexplain, right before the huge slide in late September and early October, goldwas still moving to new intraday highs; the HUI Index was ignoring that, andthen it declined despite gold’s rally. However, it was also the case that thegeneral stock market suffered materially. If stocks didn’t decline back then soprofoundly, gold stocks’ underperformance relative to gold would have likelybeen present but more moderate.
Nonetheless, the HUI Index’s bearishhead-and-shoulders pattern is already sounding the alarm. When the HUI Indexretraced a bit more than 61.8% of its downswing in 2008 and in between 50% and61.8% of its downswing in 2012 before eventually rolling over, in both (2008and 2012) cases, the final top – theright shoulder – formed close to the price where the left shoulder topped. Andin early 2020, the left shoulder topped at 303.02. Thus, three of the biggest declines in the mining stocks (I’m using theHUI Index as a proxy here), all started with broad, multi-monthhead-and-shoulders patterns. And in all three cases, the size of the declinesexceeded the size of the head of the pattern.
In addition, when the HUI Index peaked onSep. 21, 2012, that was just the initial high in gold. At that time, theS&P 500 was moving back and forth with lower highs. And what was theeventual climax? Well, gold made a new high before peaking on Oct. 5. Inconjunction, the S&P 500 almost (!) moved to new highs, and despite bullishtailwinds from both parties, the HUI Index didn’t reach new heights. Thebottom line? The similarity to how the final counter-trend rally ended in 2012(and to a smaller extent in 2008) remains uncanny.
As a result, we’re confronted with twobearish scenarios:If things develop as they didin 2000 and 2012-2013, gold stocks are likely to bottom close to theirearly-2020 low.If things develop like in 2008(which might be the case, given the extremely high participation of theinvestment public in the stock market and other markets), gold stocks couldre-test (or break slightly below) their 2016 low.
Keep in mind though: scenario #2 mostlikely requires equities to participate. In 2008 and 2020, sharp drawdowns in the HUI Index coincidedwith significant drawdowns of the S&P500. However, with the Fed turning hawkish and investors extremely allergicto higher interest rates, the likelihood of a three-peat remains relativelyhigh.
As further evidence, let’s analyze thebehavior of the GDX ETF and the GDXJ ETF. Regarding the former, the seniorminers celebrated gold’s strength by falling to their previous lows on Jul. 8.If this is not a shocking proof of extreme underperformance, then I don’t knowwhat would be one.
Please see below:
Regarding the latter, on Jun. 29 (theJune low), the GDXJ ETF closed at $45.83. And on Jul. 8, it closed at $45.53.Ladies and gentlemen, we had a breakdown.
Of course, we see that the breakdown wasinvalidated, but the fact that it moved to new lows while gold rallied isextremely bearish. It seems like the junior miners simply can’t wait to breakto new lows.
The bottom line?
If gold repeats its June slide, it willdecline by about $150. Taking the entire decline into account (since August2020), for every $1 that gold fell, on average, the GDX was down by about 4cents (3.945 cents) and GDXJ was down by about 6.5 cents (6.504 cents).
Thismeans that if gold was to fall by about $150 and miners declined just asthey did so far in the past year (no special out- or underperformance), theywould be likely to fall by $5.92 (GDX) and $9.76 (GDXJ). Given the Jul. 8closing prices, this would imply price moves to $27.76 (GDX) and $35.78 (GDXJ).So, the profits on the current short position are likely to soar.
In conclusion, while the HUI Index, theGDX ETF and the GDXJ ETF are likely to have some small breathers along the way,their sprints lower are likely far from finished. When we combine their extremeunderperformance relative to gold with the bearish 2008 and 2012 analogues, thegold miners might just huff and puff and blow their own houses down. As aresult, while 2021 has already delivered two desperate pleas for more oxygen,the trio will likely require a third ventilator in the coming months. Theoutlook for the following weeks remains very bearish.
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Przemyslaw Radomski, CFA
Founder, Editor-in-chief
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