Gold Stocks Very Overbought / Commodities / Gold and Silver Stocks 2019

The gold miners’ stockshave grown very overbought after soaring dramatically higher in recent months.  Blasting really far really fast has left thissector really stretched technically and sentimentally.  Excessive gains and greed always soon lead tomajor corrective selloffs, which are necessary to restore balance.  All bull markets, even the most powerful,flow and ebb.  Big uplegs are inevitably followedby corrections.

With gold and gold stocksplunging hard Thursday morning, the timing of this research thread is certainlylucky.  My weekly-web-essay workflow is well-defined,this happens to be the 877th I’ve written. I have to decide on each week’s topic by early Wednesdays, to dothe research and build necessary spreadsheets and charts that day.  Then I write and proof these essaysThursdays, so they can be published early Fridays.

Even before this latestbout of selling erupted, the serious downside risks facing overbought goldstocks were readily apparent.  Accordingto virtually every technical indicator out there, this sector was looking ever-moreextreme in recent weeks.  The longer and farthergold stocks surged, the greater the odds for a selloff.  I warned about this Saturday morning in the conclusion to our latest monthlynewsletter for subscribers.

Before the selling hitI wrote, “Gold is overextended, due for a healthy bull-market correction overthe near-term.  Its technicals are waytoo overbought, and its sentiment way too greedy.  Too many buyers have flooded in too quickly, exhaustinggold’s near-term upside potential.  Mybest guess is a 6%-to-12% gold selloff, which the major gold stocks willleverage like usual by 2x to 3x.”  Thatworks out to 12% to 36%!

Stock prices can’t soarhigher without material interruptions indefinitely.  Even strong uplegs eventually burn themselvesout, attracting in all interested buyers over the near-term.  They rush to buy to ride the upside momentum,basking in the warm greed.  But oncetheir capital firepower is exhausted, price gains stall and peak.  That leaves nothing but sellers, and theirresulting downside momentum feeds on itself.

The massive gains goldminers’ stocks enjoyed in recent months have truly been extraordinary, stokingwidespread greed.  This first chart is aseasonal one, rendering this sector’s price action in like indexed terms during every summer in modern bull-market years.  Normally gold and gold stocks face seasonaldrifts to slumps in market summers, the dreaded summer doldrums.  This summer’s monster rally defied that.

Traders use two major benchmarksto measure gold-stock prices, the popular GDX VanEck Vectors Gold Miners ETF and thevenerable HUI NYSE Arca Gold BUGS Index. Both of these track the major gold miners’ stocks.  While GDX has gradually usurped the HUI in prominence,it remains too young for long-term studies. GDX was born in May 2006, roughly halfway through the last secular goldand gold-stock bull.

So the HUI has to beused to distill all gold-stock summer action from 2001 to 2012 and 2016 to2019, the modern gold-bull-market years excluding intervening bear years.  Every summer is individually indexed to itsfinal May close, which is set at 100. Then its June, July, and August price action is recast from that commonbaseline.  All these individual-summerindexes averaged together show the summer-doldrums drift.

The center-mass trendof this spilled-spaghetti chart is a sideways grind, within 10% eitherdirection of the final May close.  This summer’sbreakout gold-stock rally is rendered in dark blue, and it proved an uttermonster.  By the end of August, the HUIhad skyrocketed 45.3% higher during the three calendar months of the marketsummer!  The seasonal average in modern gold-bull-marketyears before 2019 was a 3.2% gain.

The gold miners justsoared to their best summer performance in recent decades!  The only comparable year was 2016, making itsexample important for gaming today’s overboughtness.  The gold stocks spent the last few monthsracing higher neck-and-neck with the summer of 2016, trading the lead back andforth multiple times.  It wasn’t untilthe last couple weeks that 2019 injected the nitrous and screamed past.

By the end of July2016, the HUI had soared 36.3% summer-to-date compared to 2019’s considerably-smaller26.9% gains in that same span.  But bythe end of August 2016, those had collapsed back down to +10.1% over thatentire summer.  This summer’s strongfinish after a powerful multi-month rally is truly in a league of its own.  Only 2003 rivaled it with 36.9% summer gains,but those started well later mid-summer.

Overboughtness is arelative thing, it can’t be defined absolutely since prevailing price levelsgradually change over time.  But thebiggest summer gold-stock rally in modern history certainly raises concerns ofrunning too far too fast.  Goldstocks soaring by about half in several months is a huge move even by theirwild standards!  This mighty gold-stocksurge looks even more extreme considered in longer-term context.

This next chart encompassesthe current gold-stock bull since early 2016, which was driven by gold’s ownparallel secular bull.  Professional institutionalinvestors have often gamed this bull with that leading and dominant GDX ETF, soit is used here rather than the older HUI. While the gold miners’ stocks achieved much technically this summer,there’s no doubt they soared to super-overextended levels which is ominous.

As of this Wednesday’sclose, the data cutoff for this essay, GDX had powered up 76.2% in 11.8 months.  Interestingly that’s right in line with thelast secular gold-stock bull’s average upleg gain.  From November 2000 to September 2011, the HUIskyrocketed 1664.4% higher over 10.8 years! Those gains accrued in 12separate uplegs.  Excluding ananomalous post-stock-panic-recovery one, they averaged 80.7% gains.

It’s hard to believenow, but back in early May GDX languished at $20.17 and you could hardly give awaygold stocks!  Traders didn’t want anythingto do with them when they were universally despised and easy to buy incrediblylow.  I was pounding the table on buyingthe dirt-cheap gold stocks last spring, when this sector still had massive near-term upside potential.  Near-record gold-futures shorting portendeda major upleg.

Near the end of April inan essay on gold futures, I explained why.  “Speculators’ big bearish shift in gold-futurespositioning will have to be normalized, resulting in big buying that will pushgold higher.  That upside momentum couldreally grow...  The biggest gains as goldmean reverts back higher will come in the stocks of its miners.  They’ve proven resilient as gold swooned, andare poised to surge again.”

The out-of-favor goldstocks ground along near demoralizing lows for most of May, giving tradersplenty of opportunities to buy relatively low before they ran again.  We took advantage of that then to aggressivelyload up on fundamentally-superior gold miners and silver miners in oursubscription newsletters.  Trump of allthings proved the catalyst to awaken gold and thus its miners’ stocks.  That happened at the end of May.

Gold and gold stocksstarted surging after Trump threatened Mexico with tariffs, in an attempt toforce it to stem the flood of illegal immigration into the US.  Tying trade tariffs to other issues stunned traders, which unleashed safe-haven buying in gold.  That helped the gold stocks rally stronglythough much of June, with bullish momentum. But they really didn’t start soaring until late that month on amomentous gold milestone.

While gold technicallyremained in a bull market, it hadn’t made a new bull-market high since right afterthis bull’s maiden upleg way back in early July 2016.  After 2.9 years with zero new highs, tradershad long since lost interest in this sector.  But in late June after the Fed shifted itsfuture-rate-hike outlook from hiking to cutting, gold finally staged a decisive bull-market breakout.  That changed everything psychologically.

The best gold levelsseen in 5.8 years lit a fire under gold stocks, which kept rallying sharply inJuly when they are usually forgotten. They were getting overbought by mid-July, so momentum flagged headinginto month-end.  They were starting toroll over into what would’ve likely been a pullback until Trump surprised again,hiking tariffs on China as August dawned. That ignited gold stocks’ latest surge earlier last month.

That too soon startedto fade since the gold stocks were so overbought.  Smart traders who’ve dedicated many years tostudying and understanding market cycles realized a corrective selloff was increasinglylikely after such a big and fast surge. But yet again in late August Trump surprised with still another hike onChinese tariffs!  That sparked and fueledanother gold and gold-stock rally that persisted into this week.

The result of thesethree catalyzing Trump-tariff-hike announcements in recent months is the near-verticalgold-stock surge seen in these charts. GDX blasted to its best levels in 3.1 years.  That’s not necessarily high absolutely, butit is certainly high relatively.  Whenprices surge really far really fast on major buying as sentiment turns greedy, overboughtnessalways results.  Such blistering rallies inevitably lead to selloffs.

While traders chasingthe herd to buy in high later in uplegs practically panic when major selloffshit, they are actually very healthy.  Theyare essential and necessary to rebalance sentiment, eradicating theout-of-control greed after excessive gains. They force prices lower until technicals grow oversold as popular psychologywaxes bearish.  That leaves gold stocksrelatively low again, a great opportunity to buy back in.

These inexorable upleg-correction cycles arewhat enable shrewd traders to multiply their wealth in bull markets.  The goal is to buy relatively low after thecorrections, then sell relatively high after the uplegs.  This can only be achieved by doing what’sunpopular, fighting the crowd to do the opposite.  When other traders are scared and selling iswhen to buy low, then when they are excited and buying is when to sell high.

The challenge isdefining relatively low and relatively high, seeing oversold and overboughtconditions in real-time when they can be capitalized upon.  While there are many technical indicators,one of the best is among the simplest. It just looks at prevailing price levels relative to their 200-daymoving averages.  I call this Relatively Trading, and starteddeveloping this system over 15 years ago. It has proven really profitable.

There’s no gold-stocklevel that can be considered high absolutely across different years andtoppings.  In early August 2016, GDXpeaked at $31.32.  From there it wouldplummet 39.4% over the next 4.4 months in a colossal selloff!  That was considered a correction instead of abear market since gold-stock bull-and-bear cycles are defined by gold’s own.  But GDX peaked at $66.63 in September 2011 withgold’s last bull.

Is GDX high at $31,which it again challenged this week, or does it have to get to $67 to behigh?  Gold stocks’ absolute price levelsare irrelevant, as what is exceptionally high or low gradually changes over time.  So some kind of referencepoint is needed to identify overboughtness and oversoldness right as theyhappen, but that too needs to slowly evolve. I’ve found gold stocks’ 200dma acts as an ideal metric for this.

200dmas aren’t static,they gradually adjust to different prevailing gold-stock price levels.  At the same time, they have enough inertia tolag extreme short-term price moves. Calendar months average about 21 trading days, so a 200dma digests thepast 9.5 months of price action. Exceptional gold-stock moves stretch current prices far away from theirtrailing 200dmas.  That distance iseasily quantifiable to trade upon.

Relativity Trading simplydivides daily price closes by their 200dmas and charts the resulting multiplesover time.  With a sufficiently-longspan, especially in trending markets, horizontal trading ranges of thesemultiples form.  After much study and trialand error, I settled with the last 5 calendar years to define Relativity tradingbands.  Seeing where 200dma multiplestrade comparatively offers good buy and sell signals.

Again GDX is much newerthan the HUI with a far-shorter price history. And all my years of work applying Relativity to trading gold stocks hasused the HUI as their benchmark index. So I’m going to shift back to the HUI for this final chart on gold-stockoverboughtness.  The Relative HUIindicator, or rHUI, currently has a trading range of 0.80x to 1.50x.  This is rendered in this chart with the greenand red shaded zones.

Visually a Relativitychart effectively flattens a 200dma, straightening it to 1.00x.  Then a price’s multiple to that 200dma oscillatesaround it over time, in perfectly-comparable percentage terms regardless ofthe prevailing price levels.  No matterwhere gold stocks are trading, when the rHUI hits 0.80x or 1.50x the actual HUIis trading at 80% or 150% of its current 200-day moving average.  Here is this gold-stock bull’s chart.

Thanks to the goldstocks’ blistering rally this summer, the rHUI shot up as high as 1.362x lastweek.  On Wednesday as this upleg’slatest high was hit, the rHUI still ran 1.354x. In other words, the major gold stocks as a sector are stretched 35% to36% above their 200dma!  That is veryoverbought, and doesn’t happen very often. Gold-stock uplegs usually only deviate from their 200dmas so greatlywhen they go terminal.

Bull-market uplegsusually start gradually, with not many traders interested in buying relativelylow after major corrections.  But as uplegsgather steam and gains mount, traders get excited about the upside momentum andwant to buy in.  The higher prices climb,the more greed grows and the greater the allure of chasing the herd.  Thus upleg gains tend to be back-loaded, themajority accruing quickly as uplegs mature.

So really-overboughtreadings generally only happen late in uplegs.  Actual gold-stock topping levels in rHUI termsstill vary greatly though.  Back in this bullmarket’s mighty maiden upleg peaking in summer 2016, the rHUI soared as high as1.70x before drifting back to 1.62x when gold stocks actually crested in earlyAugust.  But anytime the major goldstocks stretch 25%+ above their 200dmas, traders need to be wary.

Since there’s so much variabilityin upleg toppings, I generally haven’t sold trading positions outright.  My strategy is usually to ratchet up trailingstop losses as prices get more overbought. That effectively locks in more of our upleg gains, while preservingupside potential if the upleg persists even longer.  Although stop losses have their own challengesas they can be whipsawed into tripping early, they help manage risk.

I also consider gold-stockoverboughtness in rHUI-multiple terms against the backdrop of how speculatorsare currently positioned in gold futures.  Gold stocks are effectively leveraged plays ongold, and the gold-futures traders dominate gold’s short-term priceaction.  I last explained this in depth ina mid-July essay.  For our purposes today, realize gold’s ownselloffs driving gold stocks’ are almost always governed by futures.

In the latest weeklydata, speculators held their second-highest levels of gold-futures longcontracts on record!  That left their totallongs running 97% up into their gold-bull-market trading range since mid-December2015, which was topped by July 2016’s all-time-record high.  When specs are effectively all-ingold-futures longs, all they can do is sell. Excessive long positions precede major corrections in gold.

After that only timespec longs were slightly higher in mid-2016, gold plunged 17.3% over the next5.3 months which hammered the gold stocks 39.4% lower per GDX!  And on the short side of gold futures, in thelatest weekly read specs’ total contracts were running just 11% up into their owngold-bull-market trading range.  Thatmeans they also have little room to buy gold futures to cover shorts, but lotsof room to sell.

The most-bearish-possiblenear-term outlook for gold happens when total spec longs and shorts swing to100% and 0% up into their bull-market trading ranges.  The latest 97% and 11% as of last Tuesday’sclose is getting pretty darned close! Since gold stocks will tank with gold regardless of how overbought theyget, their downside risks are high.  Amajor correction is far more likely than additional material rallying.

Rather amusingly, warningof overboughtness and impending selloffs after powerful uplegs always gets peopleriled up.  After these 877 weekly essays,I know my e-mail inbox will be full of people telling me what a fool I amMonday morning.  How could gold stocksnot soar to the moon?  This time is differentbecause...  The irony is traders shouldwelcome corrective selloffs as they create new buy-low opportunities.

I opened with the firstthird of my conclusion from our brand-new monthly newsletter, and here’s therest.  “That will rebalance sentiment, pavingthe way for far-bigger future gains.  There’s no sense redeploying capital highbefore that inevitable selloff arrives.  Don’tlet that short-term bearishness cloud the big picture.  Gold’s powerful surge higher in the lastseveral months changes everything going forward.”

“It confirms gold isindeed in a secular bull market!  Thatwas ignored and disputed for years since gold failed to break out to new bullhighs.  Gold’s decisive breakout andrallying since ballooned interest in it. So future gold and gold-stock uplegs are going to attract way morecapital from way more traders around the world, growing them to much-largersizes.”  This latest upleg was fun, but biggerand better are coming.

To multiply your capitalin the markets, you have to trade like a contrarian.  That means buying low when few others arewilling, so you can later sell high when few others can.  In the first half of 2019 well before gold’s breakout,we recommended buying many fundamentally-superior gold and silver miners in ourpopular weekly and monthly newsletters.  We’ve recently realized big gains including 109.7%, 105.8%, and 103.0%!

To profitably trade high-potentialgold stocks, you need to stay informed about the broader market cycles thatdrive gold.  Our newsletters are a greatway, easy to read and affordable.  They drawon my vast experience, knowledge, wisdom, and ongoing research to explain what’sgoing 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 the next upleg as they are deployedin real-time.

Thebottom line is gold stocks are very overbought. The powerful counter-seasonal rally in recent months catapulted gold-stockbenchmarks far beyond their 200-day moving averages.  Such stretched technicals coupled with very-bullishpopular sentiment are a warning this recent upleg is maturing.  It is likely to roll over into a healthycorrection soon to restore balance, driven by gold-futures selling from spec extremes.

All bullmarkets flow and ebb, with big uplegs followed by major corrections.  Fighting the latter is utterlypointless.  Ride the bull-market wavesrather than drowning in them.  Buy relativelylow near the troughs, then sell relatively high near the crests.  That means buying when everyone else isscared, before selling when everyone else is greedy.  After enjoying a great and very-profitableupleg, we can cash out for the next one.

Adam Hamilton, CPA

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