Gold Stocks Correction Underway / Commodities / Gold and Silver Stocks 2019

The gold miners’ stocksare correcting.  They’ve been sliding anddrifting lower on balance since their powerful recent upleg peaked a month ago.  Corrections are normal and healthy in ongoingbull markets, rebalancing sentiment to pave the way for the next upleg.  They also offer the best buy-low opportunitiesseen inside secular uptrends.  Deployingcapital in gold stocks after corrections multiplies wealth-building potential.

While most people dreadcorrections, battle-hardened speculators and investors embrace them.  They make prices oscillate around theirbull-market uptrends, greatly expanding their overall travel.  The more price movement, the more potentialupside to ride.  Today’s gold-stock bull provesthis.  Consider it in terms of the most-populargold-stock benchmark and trading vehicle, the GDX VanEck Vectors Gold MinersETF.

This gold-stock bullwas born in mid-January 2016, from the depths of despair after a secular goldbear.  Over the next 6.4 months, GDX skyrocketed151.2% higher in an epic maiden upleg!  Thatinitial early-August-2016 peak has yet to be eclipsed, but GDX came within 1.2%as this latest upleg peaked in early-September 2019.  So the maximum potential gains by buying andholding this entire bull are still 151.2%.

But it has actuallyenjoyed 3 separate uplegs, that initial 151.2%, a small 34.6% into early 2017,and the 76.2% one that peaked a month ago. Add these together, and the maximum potential gains from swing tradingthis bull’s uplegs and corrections are 262.0%. That’s over 1.7x better!  Ofcourse timing the exact bottoms and tops is impossible, so let’s lop off aquarter of that potential.  That stillleaves 196.5% versus 113.4%.

Speculators buyingwithin 1/8th or so of correction bottomings and selling within about 1/8th ofupleg toppings can generate far-bigger gains than buy-and-hold investors.  That’s an achievable goal, as there areplenty of technical and sentimental indicators revealing when these keyupleg-correction reversals are likely happening in real-time.  Gold stocks are a volatile sector, so we mayas well harness that in our favor.

This first chart providesperspective on this gold-stock bull through the lens of GDX.  Its major upleg-and-correction swings so farare noted.  Since gold overwhelminglydrives gold miners’ profits and thus gold-stock price action, gold-stock cyclesare generally considered in gold terms. Despite their huge uplegs and brutal corrections, gold-stock bullspersist as long as gold’s own do.  And gold’sbull is alive and well today.

Price movements aredriven by the collective trading of all market participants.  And their individual buy-and-sell decisionsare heavily influenced by how they feel, or sentiment.  The ethereal and unquantifiable greed andfear of the herd are what define when gold-stock uplegs and corrections run outof momentum and reverse.  And there areplenty of signs when those key junctures for multiplying wealth are probablynearing.

Since this essay is onthe current gold-stock correction, I’m going to focus on the topping side.  Uplegs are ultimately constrained, they havefinite amounts of buying power available to drive them.  There are only so many speculators andinvestors interested in gold stocks at any given time, and they all havelimited capital.  So once their buying firepoweris expended, which coincides with peak greed, uplegs top then fail.

While the whole missionof trading is buying low then selling high, our natural human instinct is todo the exact opposite.  It’s hardbuying gold stocks low late in corrections, as everyone is bearish on them andassumes the downside momentum will persist indefinitely.  So after an initial short-covering spike,most of early uplegs tend to be gradual. Gold stocks have to rally sufficiently to convince skeptical traders toreturn.

But the higher goldstocks climb, the better they look and the more excited traders get.  The faster gold stocks rally, the morecapital traders deploy.  The more theybuy, the faster gold stocks climb.  Thispowerful virtuous circle directly fueled by greed often drives prices sharplyhigher heading into the ends of uplegs. Eventually everyone interesting in buying anytime soon has already bought,so buying potential is exhausted.

The main technical indicatorwarning that gold-stock uplegs are likely peaking is how overextended GDX stretches.  Measuring this empiricallyrequires some kind of baseline, but it can’t be static since prevailing gold-stockprice levels are always changing.  Myfavorite has long been the 200-day moving average.  With nearly 10 months of trading days feedinginto it, it only changes gradually yet still slowly follows prices.

GDX’s 200dma is renderedin black in this chart.  Note above thatboth of this bull’s major uplegs saw GDX soar far above its 200dma.  Those were signs of overboughtness,that too much capital was flooding into gold stocks too quickly to be sustainable.  The faster and more exciting gains after along and strong upleg, the greater the odds they will soon run out ofsteam.  They rapidly suck in allnear-future buying potential.

Well over a decade agoI developed a trading system based on how stretched prices were relative totheir own 200dmas, called RelativityTrading.  It simply divides a priceby its 200dma yielding a multiple.  Overtime in trending bull markets these form horizontal trading ranges, withdistinctive topping and bottoming zones. Since I started analyzing this years before GDX was even born, I use theolder HUI gold-stock index.

GDX’s latest uplegpeaked at $30.95 on September 4th.  A couple days later I published an essay warning“Gold Stocks Very Overbought”explaining why and the implications in depth. On that peaking day, GDX had soared way up to 1.341x its 200dma.  For most gold-stock bull-market uplegs, seeingindex prices stretched 30%+ above their 200dmas is a big warning sign.  It means prices have run too far too fast.

Sentiment extremes always coincide with priceextremes, since how traders feel is totally dependent on how prices arefaring.  When uplegs are topping, telltaleemotions run rampant.  Widespread greedmixes with exuberance, complacency, and even euphoria.  When gold-stock prices are topping, traders asa herd are totally convinced the gold miners are on the verge of surging muchhigher.  It is funny to watch.

Buying low then selling high requires beingcontrarian, actively fighting the crowd to do the opposite.  But being contrarian requires so much hardtraining and emotional discipline that few bother painfully forging that mindset.  So most traders, and most analysts and marketcommentators, just follow the momentum. They are most excited and eager to buy when prices are high, when populargreed infects their market outlooks.

While you can easily figure out when pricesstretch really far over their 200dmas, sentiment isn’t directly measurable.  But it can be inferred by paying attention toyour own emotions and those of other traders and analysts.  If prices have rallied long and far and youare really excited and bullish, you are getting greedy.  If you are buying gold stocks when it feelsgood and validating, odds are you are buying late and high.

When gold-stock uplegs are topping, thewidespread bullish sentiment becomes evident in the financial media.  Most of the time this small contrarian sectoris totally ignored.  So when you seeprofessionals on CNBC and Bloomberg appear much more often waxing bullish on thegold miners’ stocks, that’s a major warning sign.  Financial television is very useful becauseit reflects and reveals prevailing sentiment!

Most gold-stock speculators and investors alsofollow some commentators, as not everyone can or wants to spend all day everydaystudying the markets.  Usefulness derivedfrom market analysis is dependent on how a particular analyst thinks.  Are they a herd-follower momentum trader or acontrarian?  You need to figure that out beforeyou trade on anyone’s advice.  A little homeworkwill clarify how they tend to think.

Look at what your commentator waspredicting in real-time at known past major gold-stock toppings andbottomings.  In early August 2016 andearly September 2016 as gold-stock euphoria reigned, did they call for bigadditional gains?  Or did they warn of animminent correction.  Contrarians areeven rarer publicly since being in this camp draws mockery.  Traders hate hearing when their beloveduptrends are ending!

So between how you feel about gold stocks,how professionals interviewed in the financial media feel, and how your favoritecommentators feel, you can get a good idea of prevailing sentiment.  Chances are if you are excited about buyinggold stocks, much of the driving upleg has already run its course.  The time to buy is when it feels miserable,after gold stocks have fallen so far that they seem hopeless again.

As a newsletter guy for the past coupledecades now, I have an additional sentiment-revealing conduit that issuper-valuable.  I’m constantly e-mailedfeedback and questions from subscribers. They grow excited about gold stocks when uplegs are topping, and depressedwhen corrections are bottoming.  It isnot just a collective thing, but even individuals.  Certain people have written me periodicallyfor years on end.

They’ve proven great contrary indicators.  Like clockwork they are very bullish andexcited when gold stocks are topping, and really bearish and disheartened whengold stocks are bottoming.  If you happento be fortunate enough to talk with someone regularly who also trades thissector, you can get a similar read by asking them where they think it is going.  Unless they are hardened contrarians, do theopposite!

When technicals get really overbought and sentimentreally greedy, it’s definitely time to be wary. But I still generally don’t sell high. Gold stocks are a volatile sector that can really surprise to the upsideat times.  So instead of selling outrightand trying to catch an inherently-unpredictable precise top, instead I just ratchetup my trailing-stop-loss percentages. Tighter stops lock in more profits when prices reverse.

In early September gold stocks were verystretched technically, with GDX far above its 200dma baseline.  And everywhere you looked, traders andanalysts were wildly bullish on gold miners’ prospects.  Those were all the hallmarks of an uplegpeaking before a major correction.  But amore-obscure indicator really caught my attention.  It was how speculators were collectively positioned in gold futures, which is crucial.

I wrote a whole essay explaining this indepth in mid-September, titled “Gold-Futures-Selling Overhang”.  Gold stocks are essentially leveragedplays on gold, since it utterly dominates their earnings power.  And the primary short-term gold driver is howgold-futures specs are betting.  Likemost gold-stock traders, they are momentum followers and not contrarians.  So they grow really bullish when gold itselfis topping.

This exuberantsentiment manifests itself on both sides of the gold-futures trade, longs andshorts.  When these traders expect goldto keep rallying after a strong upleg, their long upside bets are very high.  They also radically curtail theirshort-selling downside bets.  These guysalways bet wrong when uplegs are topping, and the extreme leverage inherent ingold-futures trading means they can’t afford to be wrong for long.

Gold stocks follow gold,which is mostly driven by speculators’ gold-futures trading.  Thus whenever I’m assessing the likelihood ofa major gold-stock upleg topping, I carefully consider specs’ positioning.  If their collective bets are normal, longsand shorts both in the middle of their gold-bull-market ranges, then the oddsof gold and thus gold-stock corrections are much lower.  But when bets are extreme, watch out below.

This last chart looksat speculators’ total long and short contracts held in gold futures, which arepublished weekly.  Long upside bets arerendered in green, and short downside bets in red.  The higher longs, and the lower shorts, the morebullish gold-futures speculators.  Andthat is more bearish for gold and gold stocks over the near term!  A month ago this chart heavily influenced mywarning on gold-stock overboughtness.

In early September asgold stocks stretched far above GDX’s 200dma and bullishness was universal, thegold-futures specs’ total longs were nearing an all-time record high!  At the same time their shorts were verylow.  On September 3rd specs’ total longsand shorts were running 96% and 8% up into their gold-bull-market trading rangessince mid-December 2015.  These guys wereeffectively all-in longs and all-out shorts!

Like gold-stocktraders, gold-futures traders’ capital is finite.  They buy aggressively in gold uplegs, whichdrives them higher.  But eventually they’vedeployed all the capital they are able to wield, which leaves no more buying firepowerleft.  At that point all they can dois sell when the right news catalyst hits sooner or later.  That selling soon snowballs due to the crazyleverage, unleashing gold and gold-stock corrections.

With gold-futures speculators’potential buying nearly tapped out in early September, gold wasn’t likely to gomuch higher but had high odds of selling off. And that would drag the gold stocks with it.  The major gold miners that dominate GDX’s weightings tend toamplify underlying moves in gold by 2x to 3x.  So when that inevitable gold-futures sellinghit, it was going to hammer gold stocks particularly hard like usual.

Fast-forward to today,and spec gold-futures positioning is a key reason why gold stocks are sufferinga correction now.  The latest report onspeculators’ collective gold-futures bets last Tuesday revealed their totallongs and shorts are still running 97% and 5% up into theirgold-bull-market trading ranges!  That isclose to the most-bearish-possible for gold of 100% and 0%, guaranteeing biggold-futures selling was coming.

And indeed we saw a lotof it over the week since.  After peakingat $30.95 in early September yielding a 76.2% upleg gain over 11.8 months, GDX plunged13.9% to $26.64 over the next couple weeks. That was beyond that classic 10% correction threshold for stock markets,although gold stocks are so volatile their definition should be wider.  Then GDX rebounded fast, surging 10.7% higherto $29.49 on September 24th.

While early September’ssharp gold-stock selloff caught traders’ attention, that bounce rally rekindled lots of complacency.  It’s fittingthat secondary gold-stock topping hit the same day specs’ latest gold-futurespositioning was so extreme.  Gold fellsharply from there, dragging the gold stocks down with it.  By the end of September, GDX had plungedanother 13.7% to $26.71.  Lower highs wereforming a correction downtrend.

Still, at worst GDX wasonly down 13.9% correction-to-date.  That’snothing yet by gold-stock-correction standards. Today’s gold-stock bull has seen two prior corrections, a massive 39.4% intolate 2016 and an also-ugly 31.3% into late-summer 2018.  Both of these were excessive, exacerbated by marketanomalies heading into their climaxes. But their 35.4% average losses illustrate how serious these get.

Bull-market correctionsmost often bounce at 200dmas, and GDX’s was running $23.90 as of the middle ofthis week.  That would make for a 22.8%total correction.  But since GDX’s priceremains well above that 200dma, it is gradually rising.  So it will be somewhat higher by the time GDXis forced back down to it by specs’ gold-futures selling.  Another way to game the potential gold-stockdownside is to look at gold.

Gold’s parallel bullthat’s driving this gold-stock one also experienced those same two corrections sofar, which ran 17.3% and 13.6%.  Thataverages 15.5%.  But again those wereexcessive, made way worse by some extreme market events that aren’t going torepeat.  Gold should see a milder andmore-normal bull-market correction this time around, somewhere in the 6%-to-12%range.  GDX will amplify that by 2x to3x.

That implies agold-stock correction of 12% to 36%, for a 24% midpoint.  25% is reasonable, and right in line withpast-bull-market precedent.  During goldstocks’ last mighty secular bull across the entire 2000s decade, the average major gold-stockcorrection per the HUI was 26.1%. That excludes 2008’s wildly-anomalous stock-panic selloff, but covers fully12 other corrections.  Around 25% is parfor the course.

That implies a GDXdownside target around $23.21, another 15.3% lower from this week’slevels.  It is interesting that goldstocks’ weakest seasonals of the year from late September to lateOctober align with this as well.  Lastweek I wrote a whole essay “Gold-StockRed October” explaining why this is the case.  Everything is lined up for considerable sectorweakness in the coming weeks.  Tradersneed to be ready.

Corrections are just asentiment thing, a rebalancing to bleed off the excessive greed surroundingupleg toppings.  The buying opportunityafter this one will be really important, as gold miners’ fundamentals arerapidly improving with higher prevailing gold prices.  In the just-finished third quarter, averagegold prices soared a stupendous 12.6% higher quarter-on-quarter!  So gold miners’ earnings must have exploded.

After every quarterlyearnings season, I analyze the collective results of the GDX gold miners.  In Q2’19, their averageall-in sustaining costs ran $895 per ounce. That yielded sector profits of $414 per ounce at Q2’s $1309 average goldprice.  Assuming AISCs are flat in Q3, whenthey are actually likely to fall, those earnings soared to $579 at last quarter’s$1474 average gold price.  That’s up anincredible 39.8% QoQ!

So gold miners’ upcomingreleases of Q3 results between late October to mid-November are going to lookfantastic.  As long as gold’s ownselloff is waning, this great fundamental news may cap the worst of gold stocks’correction in time terms.  Gold stocks’powerful recent surge on gold’s decisive bull-market breakout caught traders’ attention, and the bottoming of this underway correction willbe the time to buy big.

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 gold stocks soared higher, we recommendedbuying many fundamentally-superior gold and silver miners in our popular weekly and monthly newsletters.  We later realized big gains including 109.7%, 105.8%, and 103.0%!

To profitably trade goldstocks, you need to stay informed about gold’s major drivers and their likelynear-term impacts.  Our newsletters are agreat way, easy to read and affordable.  Theydraw on my vast experience, knowledge, wisdom, and ongoing research to explainwhat’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 bottom line is agold-stock correction is underway.  Themajor gold miners have been grinding lower and sideways for a month now, afterbecoming very overbought technically. That major warning sign of upleg toppings was accompanied by exuberantpopular sentiment.  On top of that,speculators’ gold-futures positioning was and is again excessively bullish, signalingmajor gold selling is inevitable soon.

Corrections should beembraced, not dreaded.  They are normaland healthy in bull markets, existing to bleed off excessive greed and restore sentimentbalance.  These selloffs offer the bestopportunities to buy relatively low within ongoing bulls.  Traders need to watch for them, prepare forthem with stops, and hold off on redeploying stopped capital until they’ve runtheir courses.  Then jump back in to ridethe next upleg!

Adam Hamilton, CPA

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