Gold Mining Stocks – Back up the Truck?

Thu, Jun 22, 2017 - 12:03pm

Over the last few years, Gold Mining stocks have carried investors on quite a ride. This observer first started watching the Gold Stock Index back in 1978, when mining stocks were the only game in town. Back then, in Los Angeles, a local business television station (“The Business Channel”) updated the quote board on the mining stocks every fifteen minutes live on television, featuring South African miners like Kloof, Durban Deep, Western Deep Levels, Buffelsfontein, Harmony, as well as North American miners like Battle Mountain Gold, Echo Bay Mining, Sunshine Mining, Giant Yellowknife, and Callahan Mining. At the peak for Gold in 1980, investors stood outside gold coin stores in Los Angeles in the early morning in lines that stretched a city block or more. The same was also true to buy T-Bills, which at the time were paying nearly 14% interest on three-month money, and where lines at banks stretched city blocks long on Saturday mornings. Oh, how the world has changed.

I started the Gold Stock Technician Newsletter in 1993 and wrote about mining stocks weekly for over 20 years. At the peak in October 2011, I sat for an interview where I had turned bearish on the mining stocks and called for a better than 50% decline to get underway. At the time, this was going against a very popular tide and wildly exuberant sentiment, and as a result, I ended up getting over 2,000 emails telling me how wrong I would be, most of them less than kind.

Unfortunately, the decline not only materialized but ended up extending and becoming even larger, with the Philadelphia Gold Index (XAU) declining from a high of 8.96 on September 9, 2011, to a final low of just .36 on January 22, 2016. That decline measured -83.24% and was mimicked by a -81.48% decline in the popular Market Vectors Gold Mining ETF (GDX).

The chart above shows the huge bear market in Gold Stocks and the subsequent major low that occurred in January of last year. Notice that the ensuing rally was very powerful and easily broke the group out above the long-standing declining trend line. From the low on January 22, 2016 of .36 on the XAU to the subsequent high of 4.71 on August 12, 2016, the XAU gained 199.03% in seven months, while GDX gained 156.37%. Since then, a long and dull downward correction has been in effect with prices recording important medium-term lows in late December of last year. For the XAU, that bottom came at .63, which represented a sell-off of -37.55%, and for the GDX a decline/pullback of -41.55%. There is never anything mild when bringing up the discussion of mining stocks.

While it is never easy to accurately forecast in real time when the mining stocks are near an important turning point, at the present time, there are some very loud bells ringing that suggest yet another important bottom—possibly a major low—could be close at hand.

Above: Short Term Ratio of Total Up to Down Volume for Gold Stocks

In the chart above, I show a picture of the GDX ETF in the upper clip and my Short Term Up to Down Volume gauge in the lower clip. One of the wonderful features of an ETF like GDX is the ease of entry and exit, where the ETF virtually trades like water every day, averaging about 58 million shares turnover on a 90-day basis, down from a peak last June of around 89.3 million shares per day. For the Up to Down Volume gauge, the typical overbought and oversold parameters are overbought readings above 2.00 and oversold values below 0.50. Over the last five days, we have seen readings of 0.26 on Tuesday, June 20, 0.299 on Monday, June 19, 0.327 on Friday, June 16, 0.397 on Thursday, June 15 and 0.505 on Wednesday, June 14. In the 10,198 trading days seen since early 1977 (a period a little over 40 years for which data on this indicator exists) there have been only 136 trading days which have a value of 0.26 or lower. That puts the mining stocks currently in the 98th and almost the 99th percentile of oversold daily values.

While this does not mean that they cannot go down even further over time, it does suggest strongly that a potential near-term rally could be getting close. If that rally is strong enough, it could then change the direction of the intermediate term, which right now is pointed down. In my view, the advance which was seen from January to August of 2016 represented a kick-off move for a new secular bull market. Those who follow Elliott Wave analysis would label this as a Primary Wave [1] up. Since then, the downward corrective pattern that has been in force coming up on one year has been Primary Wave [2]. There is a reasonably high probability that Primary Wave [2] already bottomed last December and that a nascent start to the next advancing wave is already slowly taking shape. The alternative view would be that prices still need to retest the December 2016 lows before they can truly resume the larger advance.

In the chart above, I show my own Unweighted Gold Stock producers’ Index that would require approximately another 10% (9.8%) decline to fully match the late December lows of last year.

However, several factors are starting to strongly suggest that the need for a full retest is no longer necessary. For starters, in many cases, a “close approach” or “partial retest” of the lows will suffice. Second, the near term price behavior has already brought the major gold producers back down into the range of last year’s lows and seems to be forming a potentially major double bottom.

One element where the ETFs of today are not that helpful is lumping in very different kinds of companies. In the GDX ETF for example, the ETF places a high weight on several Gold Royalty companies with names like Wheaton Mining, Franco Nevada, and Royal Gold, making up a significant weight of the overall basket. There are also other companies in the ETF where the inputs to the bottom line come from base metal credits such as zinc, copper, nickel, et all. Some of these companies have a much lower correlation to the overall group and act somewhat like outliers. In the case of the royalty companies, they do not actually possess a mining operation, but instead act more like banks collecting what in the mining business is called NSRs or Net Smelter Royalties. The shares of these companies are remarkable in the sense that they are remarkably profitable over time, and have very unique characteristics far apart from true gold producers.

In the chart above, the top clip shows the true gold producers which operate mines and employ thousands of people. The middle clip is an index of gold royalty companies and other oddball gold-related names that are correlated to gold mining stocks, but somewhat less correlated and less volatile (far more stable) than gold producers. The bottom clip is the GDX ETF, which is a blend of the top two. Right now, there has been a consistent strength for weeks in the royalty companies where earnings and revenue growth is very positive. Producers, on the other hand, have been struggling and are much more leveraged to small changes in the gold price.

In my view, what we have here is really a tale of two somewhat different markets, and the ETF is muddling the overall view. It is the producers right now that are on the bargain counter, in many cases selling at a very low historic price to cash flow multiples, and where the price of the shares is essentially close to a full retest of last year's lows. Other technical gauges such as the McClellan Oscillator for Gold Stocks and, even more importantly, the Intermediate ARMS Index are now deeply oversold.

Above: the McClellan Oscillator for Gold Stocks also ended below -250 for another session with a reading of -264, up slightly from -275 on Friday.

Above: Intermediate ARMS Index or TRIN

The ARMS Index in particular, which is now pushing up against its upper horizontal benchmark, indicates high levels of fear and capitulation – prime ingredients for a major low. On Tuesday of this week, the ARMs closed at 1.756, up from 1.653 on Thursday, and 1.542 on Friday of last week. Any move above 1.65 is a benchmark oversold reading. In addition, since we also saw a reading of 2.068 back on March 9th of this year with GDX at .14, there is no need for this gauge to necessarily push much higher. We actually have a potentially strong positive divergence, as prices are very close to the same area as the March lows, especially the producers, while at present the Intermediate ARMS looks likely to put in a slightly lower high. That is a potentially very positive set up for a big turn UP!

Selling Intensity, which is a gauge that measures the momentum behind the selling pressure, has also now spiked up to watershed levels, at values consistent with the start of the last major bull-run seen in early January 2016.

Above: Selling Intensity is also peaking right now, and is at the same levels seen just prior to the bull market launch in early January 2016.

Finally, On Balance Volume is also now down to long-term oversold values with the 14 day RSI on GDX OBV, sitting in the mid 20s. That is the lowest daily reading in several years, and again a major indicator that a wash out low should be very near.

Near term, there is a cluster of moving averages right around .40-.50 on GDX and, over the next few days, any upside reversal above that area would likely be something of an “all clear” and would suggest that Gold Stocks are beginning to turn the corner and may have left in place a major low.

While a decline to .00 on GDX is still within the realm of potential near-term outcomes, at this point, it is starting to look a good deal less likely. We need to see some kind of bullish reversal in both GDX and above ,260 on spot gold would set a solid improving tone.

Above: GDX could be setting up a potential base and is now very substantially oversold on both a short and intermediate basis. This does not guarantee that a low has been seen, but it does suggest that much of the risk is now out of the mining sector and that the sector could be within a few days of a major low if it has not already seen that low. Upside confirmation from here would go a long way in crystallizing a potentially important change in trend.

Late Note: Gold Stocks seem to be turning up nicely at mid-day on Thursday. Updated chart is shown below. All in all, an encouraging positive sign that an important bottom could be developing. It is always good to scale into positions in the sector over time, as they can be quite volatile in the short term, so spacing out entry points is always a good strategy.

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