Gold Stocks Head Fake? / Commodities / Gold and Silver Stocks 2020

Gold miners’ stocksblasted higher this past week, breaking out of their correction downtrend.  Rapidly-improving psychology fueled suchstrong upside momentum that sector benchmarks are challenging months-old upleg highs.  Most traders assume this is righteous, that goldstocks’ next upleg is starting to accelerate. But key indicators argue the contrarian side, that this breakout surgeis a head fake within a correction.

In early September, amajor gold-stock upleg peaked after soaring higher on gold’s decisive bull-market breakout in late June.  The GDX VanEck VectorsGold Miners ETF, this sector’s leading benchmark and trading vehicle, had powered76.2% higher over 11.8 months.  It crestedthe same day gold’s own upleg did, hitting $30.95 on close.  That major 3.1-year high proved the apex ofthat impressive gold-stock upleg.

Gold started grindinglower after its own September 4th upleg zenith of $1554, capping a massive 32.4%run over 12.6 months.  The gold stockscorrected with gold like usual, as these miners are essentially leveraged playson gold.  Since their earnings amplifygold-price changes, the major gold stocks dominating GDX generally leveragegold by 2x to 3x.  So the goldstocks drifted lower over the next several months.

At worst GDX was down15.4% over 1.3 months by mid-October, although it would narrowly miss new correctionlows by pennies in both early and late November.  Gold’s own selloff hit its correction-to-datenadir on Thanksgiving Eve, falling 6.4% over 2.8 months.  Both of these corrections were really mildand short by their own bull-to-date standards.  And neither GDX nor gold fell anywhere neartheir own 200dmas.

Gold-bull corrections aftermajor uplegs almost always drag prices back down to their 200-day movingaverages before giving up their ghosts. These key technical lines are major support within ongoing bullmarkets.  200dma approaches helpcorrections complete their missions of eradicating the excessively-bullishsentiment at previous upleg toppings.  Atworst in late November, GDX was still 4.7% over its 200dma.

Gold similarly appearedto evade a normal correction, retreating to 4.0% above its own 200dma in late November.  Those were serious red flags technically thatthe corrective work hadn’t yet finished. And GDX’s 15.4% loss over 1.3 months was dwarfed by this bull’s priortwo GDX corrections averaging 35.4% losses over 11.8 months.  So technically gold stocks’ correction hadn’tended cleanly heading into December.

Gold was in the sameboat, with its 6.4% selloff over 2.8 months at worst very small and shortcompared to this bull’s prior corrections averaging 15.5% losses over 6.0months.  While gold’s improving sentimenton its first new bull-market highs in several years argued for a mildercorrection, it still should’ve proven bigger than 6%.  That was after the largest upleg of this bullpushed gold to extremely-overbought levels.

Gold remained in itscorrection downtrend through most of December, but was crowding upper resistancewhich was mirroring gold’s 50-day moving average.  But early last month GDX broke out above itsown 50dma, emboldening gold-stock traders. Yet the major gold stocks still ground sideways after that until aChristmas Eve surprise.  Nothing should’vehappened on that ultra-light-volume half-day holiday session.

Gold had climbed 0.5%to $1485 the day before, edging over its own 50dma.  These 50dmas often prove upside resistance incorrection downtrends.  That piqued theinterest of technically-oriented gold-stock traders, who bid GDX 2.4% higher to$27.77.  Then out of the blue onChristmas Eve, gold surged 1.0% higher to regain $1500 on no news whatsoever!  That decisive 1%+ breakout ignited goldstocks’ own.

Gold had surged back upthrough both its correction-downtrend resistance and 50dma, implying that itscorrection might be over.  So GDX blastedanother 3.2% higher in that usually-throwaway half-day Christmas Evesession.  Closing at $28.66, those were themajor gold stocks’ best levels since late September.  That shattered the upper resistance of goldstocks’ own correction downtrend, igniting much excitement.

That surprise ChristmasEve breakout rally is readily evident in this chart, which shows GDX over thisentire gold-stock bull since early 2016. The months-old correction downtrend was no longer holding this sectorback.  So gold-stock psychology shifteddramatically in the week or so since. Traders are mostly no longer apprehensive about a deeper correction, butbelieve gold stocks’ next bull upleg is underway.

As a long-time gold-stockspeculator for decades now, I sure understand the allure of a breakout rally.  Wealth multiples fast in major gold-stockuplegs, they are exciting events.  As goldstocks power higher and greed mounts enticing in more traders, the fear ofmissing out grows great.  Doubling yourcapital in 6 to 12 months is a super-seductive proposition, and it has happenedplenty of times in modern gold-stock history.

Of course the marketswere closed on Christmas Day, but gold’s breakout rally extended on Boxing Daywith another 0.7% gain to $1511.  So GDX climbedanother 1.5% to $29.08.  After a breatherlast Friday, gold climbed another 0.3% near $1515 this Monday.  Gold-stock traders rejoiced at seeing gold’sbest levels since late September, and piled into the miners to push GDX upanother 2.1% to hit $29.49 on close.

That too was back to late-Septemberlevels, and not far from gold stocks’ last upleg peak of $30.95 hit onSeptember 4th.  In just 5 trading daysstraddling Christmas, GDX had ripped 8.7% higher!  That amplified gold’s own 2.5% surge in thatspan by 3.5x, better than the usual 2x to 3x. Throughout that breakout-rally week, commentary on gold and its miners’stocks became more and more bullish as excitement mounted.

The critical questionnow is whether gold stocks’ breakout rally is real and sustainable.  Is it the early days of this sector’s nextmajor bull-market upleg as widely assumed? Or do the shallow and short corrections after the last massive gold andgold-stock uplegs still have work to do? If they hadn’t yet erased enough greed to rebalance sentiment, newcorrection lows are still likely.  Thatwould make this rally a head fake.

Traders bristle at thislatter contrarian notion.  Yet this chartproves this bull’s prior corrections have seen powerful countertrend rallies withincorrections.  They shatter downtrendresistances, exceed 50dmas, and can even boost GDX all the way back up near prior-upleghighs.  So the mere existence of breakoutrallies offers no guarantee that corrections are over.  Corrections persist until sentiment isfinally rebalanced.

That didn’t appear tohappen after those recent gold and GDX upleg peaks.  I’ve been blessed to be in thefinancial-newsletter business for over two decades now.  My job is studying the markets all day everyday to better understand them, write about them, and make profitable trades forour subscribers.  Their feedback pours inconstantly from around the world, and collectively proves a great sentiment indicator.

Later in prior gold-stockcorrections as sentiment was bottoming, everyone was depressed.  People were giving up on this sector after itfell so hard in the preceding corrections. Doubt, fear, and despair were the common themes.  Capitulation ran rampant, withvirtually no interest in deploying more capital in this volatile contrariansector.  That’s the time to besuper-bullish on gold stocks, when most others are bearish!

But gold-stockbearishness has remained subdued at worst ever since early September.  Even in mid-October, early November, and lateNovember as GDX was hitting and challenging correction lows, that didn’t fuelwidespread worry.  This gold-stock correctionwas simply too shallow and short to eradicate greed and stoke fear.  People were mostly looking to keep buying,which is typical mid-correction psychology.

That wasn’t surprising givenhow little both gold and GDX had retreated since their upleg toppings in earlySeptember.  As discussed earlier in thisessay, the metal and its miners’ stocks hadn’t fallen anywhere near as deep orlong as their own bull-market precedents. Relatively small and short-lived selloffs don’t do much to rebalancesentiment.  So greed persists while fearfails to bloom, delaying the next upleg.

Since those recentuplegs peaked, sentiment has yet to be right to birth major new uplegs.  They are always born in fear, not greed.  While herd sentiment is ethereal and impossibleto measure, there’s an easy way to infer it. Look up what your favorite market analysts were saying about gold andgold stocks in mid-October, early November, and late November as GDX was nearcorrection lows.  It likely wasn’t bearish!

But sentiment andcorrection-to-date technicals aside, one thing all gold-stock speculators andinvestors can agree on is as goes gold so go the gold stocks.  Again the gold miners are leveraged plays ongold due to their great profits leverage to this metal’s price trends.  If gold continues powering higher, then thisrecent gold-stock breakout rally is righteous. But if gold sells off materially again, gold stocks will fall hard.

As always, gold stocks’fortunes from here depend on what gold does next.  As I’ve analyzed, proved, and discussed incountless essays over the decades, gold itself has two primary drivers.  They are what investors and gold-futures speculators are doing.  When they buy or sell, gold climbsor falls respectively.  So whether goldstocks’ breakout rally is real or a head fake hinges on what these traders arelikely to do next.

Comprehensive data onglobal gold investment is only published quarterly by the World Gold Council, andthe latest Q4 read won’t be released for at least a month yet.  But there’s a great proxy for what investorsare doing at a high-resolution daily read. That’s the holdings of the world’s leading and dominant GLD SPDR GoldShares gold ETF.  They accounted for nearlya third of the global-gold-ETF total at the end of Q3!

GLD acts as aconduit for the vast pools of American stock-market capital to slosh intoand out of gold.  When investors buy GLDshares faster than gold itself is being bought, their price threatens to decouplefrom gold’s to the upside.  GLD’smanagers must prevent this to keep their ETF tracking gold.  So they issue enough new shares to offset thatdifferential GLD demand, and use the proceeds to buy physical gold.

So when GLD’s holdingsare rising, investment capital is flowing into gold.  And when they are falling, it is moving backout.  American stock investors dumpingGLD shares faster than gold will lead to a downside tracking failure.  So GLD’s managers have to sop up that excesssupply from differential selling, by buying back GLD shares.  They raise the funds to do this by selling physicalgold.  GLD’s holdings reveal all this.

During that5-trading-day span straddling Christmas when gold and GDX surged 2.5% and 8.7%in their breakout rallies, GLD’s holdings only climbed 0.8% or 7.3 metrictons.  While that was the best cluster ofGLD-holdings builds since late September, it is still next to nothing.  Historically GLD trends have mirrored globalgold investment ones quite closely.  Overthis past week, investors weren’t materially buying gold.

And why would they withthese extreme Fed-levitatedstock markets at euphoric all-time-record highs?  Gold is a contrarian trade, the ultimately portfoliodiversifier.  It generally isn’t indemand when stocks are high and complacency is overwhelming.  And $1500+ gold may be exciting to gold-stocktraders, but it isn’t high enough to drive considerable interest outside ofcontrarian circles.  Investors weren’tbuying gold.

To show how feeble thispast week’s 0.8% or 7.3t GLD-holdings build was, consider the ones surroundinggold’s last upleg peak.  From this metal’sbull-market breakout in late June to GLD holdings’ own peak in late September, itsbullion soared 21.0% or 160.8t.  Duringtwo separate 5-trading-day spans in late August and late September, GLD’sholdings surged 3.6% or 30.5t and 3.9% or 34.0t!  That was big buying.

If investment capitalisn’t flowing back into gold in a major way, and isn’t likely to start to, goldwill have a tough time powering higher. And the single best gold-investment indicator is revealing weakinvestment demand at best so far in gold’s breakout rally.  That’s a serious problem for gold stocks, arguingstrongly for the head-fake case.  But today’sprecariousness in gold and GDX are really driven home by gold futures.

Unfortunately speculators’ gold-futures trading dominates gold’s near-term price trends.  These guys can punch far above their weightsin terms of capital deployed because of the extreme leverage inherent in goldfutures.  This week each singlegold-futures contract controlling 100 ounces of gold worth $151,700 onlyrequired traders to keep maintenance margins of $4,500 in their accounts.  That’s just mind-boggling.

These traders canlegally run extreme leverage to gold up to 33.7x!  At 10x, 20x, or 30x, every dollar that theydeploy has 10x, 20x, or 30x the price impact on gold as a dollar investedoutright.  With that kind of leveragethese guys can’t afford to be wrong for long or risk swift ruin.  So their trading time horizons are necessarilycompressed into days and weeks.  They haveto be short-term momentum followers to survive.

Upping their outsizedinfluence on gold even further, the resulting gold-futures price happens to bethe world’s reference one for gold. So gold-futures price action has far-reaching psychological impacts outin the much-larger investment realm!  Thegold-futures tail often wags the gold-investment dog.  Gold’s breakout rally can only continue if specsbuy gold futures.  That’s highly unlikelyas this sobering chart reveals.

Gold’s price in blue issuperimposed over specs total gold-futures long contracts in green and totalshort ones in red.  I explained this in depth inearly December, but in a nutshell gold-futures buying drives gold higher whileselling pushes it lower.  Buying canhappen two ways, adding new longs and buying to cover and close existingshorts.  This latest weekly data on specs’positioning reveals their buying is tapped out.

Normally this weeklygold-futures-positioning data current to Tuesday closes is released late onFriday afternoons.  But because of theChristmas holiday, the most-recent read current to Christmas Eve wasn’t publisheduntil late this Monday.  In the weekending Tuesday Christmas Eve, speculators added a huge 23.1k gold-futures longcontracts!  Anything over 20k is massive,so this fully explains gold’s breakout surge.

Big gold-futures buyingalone isn’t unusual or inherently unsustainable.  What’s really important normally and crucialfor today is where that left specs’ overall gold-futures positioning.  That 23.1k contracts of long buying in theweek ending Christmas Eve pushed specs’ overall total longs way up to 423.5k.  That was deep into nosebleed extreme-high territory,the 7th highest seen out of all 1095 reporting weeks since 1999!

Because of the ludicrousrisks inherent in hyper-leveraged gold-futures trading, there’s only arelatively-small group of speculators willing to do it.  And though their bets are super-amplified,they only collectively command a relatively-small and finite pool of capital.  Spec longs almost never get higher than about425k contracts, that is near their effective ceiling.  The all-time-record high was 440.4k back inearly July 2016.

Whether specs want tochase gold higher or not is irrelevant when their buying firepower is effectivelyexhausted.  I suspect they added morelongs over this latest week ending New Year’s Eve, pushing their bets intoeven-more-extreme territory.  That latestdata will be out late next Monday afternoon. But with spec longs right up near record highs, additional sizablegold-futures buying to push gold higher is very unlikely.

These traders can alsobuy gold futures by covering short bets. But their short-covering potential is also very limited from here, withtotal spec shorts at 83.1k contracts as of Christmas Eve.  That wasn’t much over their gold-bull-to-datelow in late November.  The gold-futuresspeculators overwhelmingly driving short-term gold price action have virtuallyno room left to buy, but vast room to sell and hammer gold lower!

In gold-bull-to-date trading-rangeterms, total spec longs and shorts were running 93% and 3% up into those rangeson Christmas Eve.  The most-bearish-possible near-term setup for gold is 100% longs and 0% shorts, since that shows buyingexhaustion leaving room for nothing but selling.  Specs had room to buy just another 21.3k contractsper their gold-bull trading ranges after that key gold-breakout-rally day.

But they had room tosell 19.3x more way up at 410.4k on both the long and short sides!  If necessary and normal spec gold-futuresselling erupts soon here to normalize their excessively-bullish bets, gold isgoing to fall hard.  Spec selling tendsto snowball since the faster and farther gold falls the more it forces other specsto dump their longs to avoid ruin.  Ifgold rolls over, the gold stocks will follow it lower like usual.

Gold’s dominant primaryshort-term driver argues its own breakout rally is a head fake within a broadercorrection.  Spec gold-futures buying ishitting a wall, and has to reverse into big selling sooner or later.  If that extends gold’s total correction to areasonable 10% or $1398, GDX is likely to plunge 20% to 30% from its ownupleg peak at 2x to 3x leverage.  That’sa lot of downside to risk on a suspect breakout rally!

I’d be really excitedabout these gold and gold-stock breakout rallies if gold investors were buyingand/or if gold-futures speculators had lots more room to keep buying.  But neither is true today.  Investors don’t seem to care, and futuresspecs are tapped out!  And withoutongoing gold buying to push gold higher, the gold stocks are in trouble uphere.  Their recent breakout rally lookslike another mid-correction trap.

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%!

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The bottom line is goldstocks’ Christmas breakout rally looks like a mid-correction head fake.  Gold’s own driving downtrend-breakout rallywasn’t fueled by sustainable investment buying. Instead speculators were aggressively piling into gold-futures longs.  But since that catapulted those upside betsback up near all-time-record highs, their buying firepower is effectivelytapped out.  There’s little left to fuelfurther gold gains.

With investors notmaterially buying gold and gold-futures speculators no longer able to, odds aregold’s breakout surge is going to fizzle out and roll over.  That’s going to unleash serious normalizationselling in gold futures that will likely cascade.  The resulting gold selloff will certainlyyank the rug out from under the surging gold stocks.  They face major near-term downside if gold’s shallowand short correction resumes.

Adam Hamilton, CPA

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