Adam Hamilton - Zeal Intelligence
The gold miners’ stocks have largely been consolidating high following last summer’s powerful upleg. That resilience has left sentiment relatively bullish, with traders mostly expecting this sector to soon start surging again. But the jury is still out on whether gold stocks will be lucky enough to evade a bigger correction. Major downside risks still abound, primarily in gold which dominates gold-stock price trends.
The reversal in gold-stock fortunes this year has been radical. This is readily evident in their leading benchmark, the GDX VanEck Vectors Gold 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 most of the first half of 2019, with GDX down 4.4% year-to-date in early May. Traders wanted nothing to do with gold stocks.
That sector slump reflected a lack of enthusiasm for gold, which was down 0.9% YTD. The gold stocks are effectively leveraged plays on gold, as their earnings really amplify changes in prevailing gold levels. But as May ended, some surprising news started sparking life back into the moribund gold realm. Trump threatened to impose big tariffs on Mexico until it stopped illegal immigration across the US southern border.
While he later stood down, it was unprecedented to use tariffs as a hardline negotiating tactic for non-trade issues. So gold caught a nervous safe-haven bid. Over the next several weeks it rallied 5.5%, which GDX amplified by 2.8x with a 15.6% surge in that span. That tracked perfectly with the major gold stocks’ normal leverage to material gold moves of 2x to 3x, which leads to outsized gains in gold uplegs.
By mid-June, gold was flirting with its first breakout to new bull-market highs in 3.0 years. Then top Fed officials collectively shifted their future rate outlook from hiking to cutting, killing a years-old tightening cycle. That big dovish shift hammered the US dollar igniting huge gold-futures buying, which catapulted gold to that long-awaited bull breakout. Traders flocked back to gold stocks to ride their metal’s surge higher.
That strong upside momentum built on itself, with buying begetting buying as speculators and investors alike love chasing winners. By early September, gold had blasted another 14.3% higher in 2.5 months! That fueled a strong 29.0% GDX surge in that short span, making for 2.0x upside leverage to gold. But such fast gains left the metal and its miners’ stocks really overbought, far above their 200-day moving averages.
I warned about that just days earlier in our monthly newsletter. “Gold is overextended, due for a healthy bull-market correction over the near-term. Its technicals are way too overbought, and its sentiment 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 alternating series of uplegs and corrections, climbing two steps higher before falling one step back. Corrections are necessary to keep bulls healthy, rebalancing sentiment after preceding uplegs. Greed, enthusiasm, and even euphoria grow too extreme after major uplegs. Those need to be bled away and largely reversed to fear, apathy, and despair before the next upleg can start powering higher.
Gold’s bull-breakout surge capped a larger 32.4% upleg that unfolded over 12.6 months, the biggest of 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 major 76.2% 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 were certainly due for breathers after such runs.
Indeed that’s exactly what happened since, as this GDX gold-stock-bull chart reveals. Gold stocks have drifted lower on balance since early September, largely consolidating high. The all-important question today is whether they can keep grinding sideways until gold’s next major upleg gets underway, or if they still have considerable downside left. While most traders assume the former, the risks of the latter remain high.
Consolidations and corrections exist on the same sentiment-rebalancing continuum, both bleeding away excessive greed common after major interim highs. The speed that greed is nullified is dependent on both how far prices fall and how long that takes. Since consolidations are much shallower, they have to last much longer to normalize gold-stock psychology. Deeper corrections are more painful, doing that faster.
Since mid-September soon after these gold and gold-stock corrections started, for the most part GDX has 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-stock resilience as a sign of strength. But early high consolidations can still fail, rolling over into larger corrections later.
Characteristics of the latter are already evident in recent months’ gold-stock action, with major miners carving a series of lower highs. That’s compressing GDX between two key resistance lines, the newer sharply-downward-sloping correction one and the older upward-sloping bull-market-upleg one. This will soon force a technical breakout one way or the other, extending or killing this recent high consolidation.
While GDX also initially saw some lower lows in this correction, they have flatlined over the past couple months. GDX sunk to $26.19 in mid-October, and challenged that two more times hitting $26.23 on close in early November and $26.20 in late November. But technically the worst of this gold-stock correction is still current to mid-October, down 15.4% over 1.3 months. Interestingly that’s reasonable relative to gold.
The yellow metal’s own correction has retreated 6.4% at worst so far as of late November, which means GDX is 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 gold stocks should be able to continue consolidating high. But if gold’s own correction isn’t over, further selling could drag the gold stocks considerably lower in coming months.
Before we get to gold, GDX’s correction so far is very mild and brief according to its own historical standards. Today’s correction is actually this secular gold stock bull’s third. The first clocked in 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 similar serious 31.3% loss accruing over 19.1 months. Together they averaged 35.4% over 11.8 months.
The precedent for big gold-stock corrections runs way farther back though. Gold stocks’ last secular bull straddling the birth of GDX ran for 10.8 years between November 2000 to September 2011. The older HUI NYSE Arca Gold BUGs index sector benchmark 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’s first-in-a-century stock panic which was an anomalously-extreme one, the other 11 averaged 26.1% HUI losses over 2.8 months. So the current gold stock correction’s 15.4% in 1.3 months is exceedingly small and short by sector standards. This small contrarian sector has a reputation for being wildly volatile for a reason. A mere 15% correction after a massive 76% upleg would certainly be a first.
If you look at all 14 previous corrections in these latest couple secular gold-stock bulls, every single one of them also had another telltale characteristic. They all at least fell back to, and usually considerably under, the major gold stocks’ 200-day moving averages per the HUI and GDX. That technical baseline is key support within ongoing bull markets. GDX plunged far below its 200dma in this bull’s first two corrections.
One way to quantify GDX’s level relative to its 200dma is by dividing this ETF’s daily closes by that moving average. That forms a construct I call the relative GDX, or rGDX. When this bull’s first correction bottomed in mid-December 2016, GDX was trading at just 0.767x its 200dma. At its second correction’s nadir hit in mid-September 2018, the rGDX fell to 0.801x. GDX plunged over 20%+ under its 200dma on average!
Yet at worst so far in today’s third 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 shallow and short-lived relative to what this sector has done in the past. That makes me wary after long decades trading gold stocks.
Gold stocks’ resilience in the last couple months resulted from residual greed, because they haven’t sold off deep enough or long enough yet to rebalance sentiment. That has really skewed another excellent indicator that flags major correction bottomings. That’s the ratio between the gold stocks and the price of gold which drives them. It is usually expressed as the HUI/Gold Ratio, because of that index’s long history.
Since the major gold stocks amplify gold’s swings by 2x to 3x, the HGR normally crests right as major gold uplegs are peaking. Back on September 4th as gold, the HUI, and GDX all hit their latest interim highs capping their last uplegs, the HGR ran 0.152x. As gold stocks’ leverage is a double-edged sword, it works to the downside too. So gold stocks look the worst relative to gold when gold corrections bottom.
That manifests itself in low HGR reads. Yet at gold’s most-recent correction low in late November, the HGR was only 0.143x. That was much higher than the HGR’s low ebb during this correction of 0.134x in mid-October. And the gold stocks have well outperformed gold since, with the HGR regaining its gold-upleg-peak levels of 0.152x twice so far in December! That’s incredibly-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 new correction lows in early and late November. At some point this greed-fueled disconnect has to be resolved. Either gold needs to rally and decisively break out of its correction downtrend, or the gold stocks need to fall to reestablish normal downside leverage. Something has to give.
The ultimate arbiter of what’s coming for gold stocks is what happens with gold. If gold’s own correction has bottomed, the gold stocks will likely get away with consolidating high and not seeing major new lows before their next upleg. But unfortunately it looks like gold’s correction isn’t over yet, which I explained in depth in last week’s essay. Gold-stock speculators and investors really need to pay attention to gold’s situation.
Without rehashing everything, gold is the dominant primary driver of gold-stock fortunes. And how gold-futures speculators are collectively trading is the dominant primary driver of gold. They wield outsized influence on gold price levels due to the extreme leverage inherent in gold-futures trading, and the fact that the resulting gold-futures price is gold’s world reference one. Specs’ current gold-futures bets are ominous.
This updated chart superimposes gold over specs’ total long contracts in green and total shorts in red. Gold corrections within secular bulls are driven by spec selling, both dumping longs and adding shorts. But so far in gold’s current correction, they haven’t done much of either yet! Thus these gold-dominating traders have vast room to sell but little room to buy, implying gold’s own near-term downside risks remain high.
This gold bull’s first couple corrections following major uplegs were driven by speculator selling. Gold fell with spec long contracts and new shorting, or falling green and rising red lines. Incidentally this essential normalization of specs’ 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 has merely retreated 6.4% over 2.8 months at worst so far. That is almost certain to grow considerably as gold-futures speculators sell down their super-high longs and ramp their super-low shorts. Both need to mean revert back much closer to normal levels. In this latest week of reporting for spec positioning, their total longs and shorts were running 85% and 1% up into their gold-bull trading ranges.
That’s perilously close to the most-bearish-possible-for-gold 100% longs and 0% shorts, which signals buying exhaustion leaving nothing but potential selling. If total spec longs’ and shorts’ gold-bull trading ranges are considered, these traders now have room to sell 392.8k contracts on both sides of the trade. That is a staggering 10.1x larger than their room to buy of 38.9k! Gold still faces massive potential selling.
The specific catalyst doesn’t matter, one always arises eventually when spec gold-futures positioning hits extremes. Vast selling has to occur before gold is out of the woods in this correction. Total spec longs are way up in their 98th percentile 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 extreme bets!
And mark my words, when gold is pummeled to new correction lows on heavy gold-futures selling the gold stocks will amplify those losses. Again the major gold stocks’ historical leverage to gold is 2x to 3x. So if the total gold correction extends to a still-modest 10%, GDX should be down 20% to 30% from its early-September peak. That works out to GDX $24.76 to $21.67, another 11% to 22% lower from this week!
And the potential near-term gold-stock downside could be even worse. Gold just enjoyed its biggest upleg of this bull, and corrections tend to be proportional. So another 15% gold correction, actually just in line with this bull’s average, certainly isn’t out of the question. If gold’s total selloff extends to 15% again, the major gold stocks will drop 30% to 45% in total. That would hammer GDX down to $21.67 to $17.02!
That’s a soul-crushing 22% to 39% below this week’s levels. While I doubt gold or the gold stocks will drop that far, their near-term downside risks remain considerable. It just seems prudent to be wary here until gold-futures speculators’ positions normalize. Until they do, gold and thus the gold stocks face way-larger-than-normal selloff potential. These corrections won’t decisively bottom until that largely passes.
The core mission of trading is multiplying wealth by buying low then later selling high. Practically that means aggressively adding gold stocks late in corrections, and then ratcheting up stop losses to harvest those big gains late in uplegs. Today the odds certainly don’t favor one of those major buy-low points being upon us. Neither the gold nor gold-stock corrections look mature yet, indicators aren’t signaling bottomings.
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The bottom line is this gold-stock correction still looks young. This sector’s selloff so far has been both shallow and short, way milder than historical precedent. These minor losses have failed to rebalance sentiment, leaving lots of residual greed. That still has to be eradicated, which is the reason bull-market corrections exist in the first place. The major correction-bottoming indicators all imply more downside coming.
Ultimately gold stocks are going to follow gold like usual, amplifying its big moves. Gold’s own correction hasn’t run its course either. Speculators’ gold-futures bets remain excessively bullish, leaving room for massive selling to normalize those positions. That will likely force gold and thus its miners’ stocks considerably lower. The resulting real correction bottomings will be the major buying op before gold’s next bull upleg.