Gold stocks still stalled

Last summer the gold stocks blasted higher with gold after its first bull-market breakout in several years. The gold stocks caught a bid before that landmark event, starting to rally at the end of May as gold surged on US-tariff fears. By early September GDX had soared 49.0% higher in just 3.2 months! Over 2/3rds of those big gains came after gold’s bull-market breakout. GDX crested with gold on September 4th at $30.95.

But it hasn’t come close to regaining those levels since, confounding gold-stock traders. That’s despite gold continuing to climb to major new secular highs of its own in early and late January. Both were fueled by geopolitics, first a flaring US-Iran conflict and later China’s scary coronavirus outbreak. But the major gold stocks failed to follow the metal higher which dominates their profits. That disconnect is really unusual.

In early January when gold surged to a new 6.8-year secular high of $1572 after the US assassinated Iran’s top general, GDX only hit $29.50. While gold was 1.2% above its original early-September peak of $1554, GDX stayed 4.7% lower than its own. Then in late January as gold rallied to another 6.8-year best of $1586, GDX merely hit $28.99. That was 6.3% lower than September 4th, despite gold being 2.1% higher!

Normally the major gold stocks amplify gold’s material advances by 2x to 3x. So GDX should’ve been 4% to 6% higher than its last upleg’s high-water mark rather than 6% lower. Because mining gold adds much more risk on top of the metal’s price swings, the major gold stocks have to leverage gold’s upside to be worth owning. They’ve certainly failed at that critical mission over the past 5+ months, decoupling from gold.

So why have gold stocks stalled out, ignoring major gold highs? And when will their normal relationship to gold resume? This GDX gold-stock-bull chart since 2016 helps illuminate what’s going on. Broader context is essential for gaming the markets. The major gold stocks are consolidating high because they needed to either do that or correct after last summer’s upleg. That was essential to rebalance sentiment.

Again GDX rocketed 49.0% higher in just 3.2 months last summer, a powerful surge over such a short span of time. That left this sector seriously overbought. Two days after GDX peaked, I warned about that in an essay “Gold Stocks Very Overbought”. GDX had stretched a massive 34.1% above its key 200-day moving average! That dangerous overboughtness then is evident in the gap between the blue and black lines.

Fighting the universal popular greed then, I concluded “…gold stocks are very overbought. The powerful counter-seasonal rally in recent months catapulted gold-stock benchmarks far beyond their 200-day moving averages. Such stretched technicals coupled with very-bullish popular sentiment are a warning this recent upleg is maturing. It is likely to roll over into a healthy correction soon to restore balance…”

Indeed that’s exactly what happened, with GDX falling 15.4% over the next 1.3 months. By mid-October it was back down to $26.19. That was fairly small by gold-stock-correction standards, as this bull’s prior two averaged ugly 35.4% losses over 11.8 months per GDX! The major gold stocks’ latest correction still needed to deepen considerably, at least dragging GDX back down to its 200dma. That never happened.

At that initial correction low, GDX remained 8.2% above that key technical baseline. That wasn’t enough of a selloff to rebalance sentiment, to largely eradicate the excessive greed seen at the preceding upleg’s topping. So that young correction prematurely truncating left much residual greed, which quickly emboldened traders. Them cutting short that necessary and healthy gold-stock selloff was pretty surprising.

GDX retested that modest low two more times in early November and late November, and it held solid. That happened to be at an interesting level technically. Note above this gold-stock correction bounced at the upper resistance line of the last upleg’s uptrend. Technically-oriented gold-stock traders were buying, hoping that existing resistance would morph into support. That kept GDX above that upleg’s trend channel.

The gold stocks mostly ground sideways in Q4, with GDX meandering between about $26 to $28. That upped the odds this sector was rebalancing sentiment a different way. Greed can be eradicated by both losses and time. The faster something corrects, the quicker greed is destroyed making room for fear. But when prices instead drift sideways on balance, greed slowly turns to apathy as traders grow frustrated.

All major uplegs are followed by either corrections or high consolidations. The former’s big losses make that necessary rebalancing work happen much faster. The latter’s lack of upside progress makes this process much slower and more discouraging. As a speculator I far prefer corrections, as they usher in the next buy-low opportunities way sooner. But consolidations are easier psychologically for investors not trading.

The major gold stocks continued to threaten to resume correcting until Christmas Eve. GDX surged 3.2% higher in that low-volume holiday-shortened session after gold broke out above its own minor correction’s downtrend. That grew into a larger 6.2% GDX rally over 4 trading days into year-end, making for normal 3.1x upside leverage to gold’s 2.0% gains. But the gold stocks couldn’t follow gold to new upleg highs.

That has certainly proven vexing for gold-stock traders given the news. When the US killed that Iranian general, and Iran retaliated by lobbing ballistic missiles at Iraqi airbases used by the US military, there were lots of fears that World War 3 was brewing! That’s the kind of thing that should make gold and its miners’ stocks soar parabolic. Yet GDX only hit $29.50, which was again 4.7% under its early-September peak.

Then a few weeks later China’s coronavirus outbreak was threatening becoming the first global pandemic in a century! That virulent and dangerous virus, which is increasingly looking bio-engineered, defied Beijing’s draconian efforts to stop its spread. The news out of China is grim and terrifying, perfect to fuel a huge gold-stock surge. Yet this sector per GDX only hit $28.99, again 6.3% under its latest upleg’s crest.

In light of these troubling geopolitical backdrops, and the resulting major new 6.8-year secular gold highs, the gold stocks have been performing poorly. As a result, GDX has carved lower highs over the past 5.3 months. That new declining upper-resistance line is converging with the last upleg’s resistance line that has turned into support. So the major gold stocks are compressing into a tightening symmetrical triangle.

That means gold stocks’ correction-defying high consolidation is running out of technical room to merely keep drifting sideways. Sometime in the next month or two, GDX either has to stage an upside breakout above its declining resistance or fail to the downside below its rising support. The former could keep this high consolidation alive, while the latter would likely push GDX lower to resume its long-stalled correction.

Interestingly that correction possibility isn’t as menacing as it was back in early September. Again just over 5 months ago, GDX was stretched a massive 34.1% over its 200dma. Greed was excessive, with gold-stock traders and analysts convinced this sector would keep blasting higher. Thankfully the high consolidation since then eradicated the majority of that greed, less enthusiasm remains for this adrift sector.

And this week GDX slumped back down to just 5.7% above its 200dma. Those were the major gold stocks’ least-overbought levels since late November’s correction-low retest, which saw a +4.7% GDX read. Thus there is much less corrective work remaining to be done compared to what the gold stocks faced in early September. The high consolidation since attenuated the worst of the downside risks facing GDX.

But how the gold stocks fare over the next month or two really depends on gold like usual. These major gold miners are effectively just leveraged plays on gold, which overwhelmingly drives their earnings and thus ultimately stock prices. If gold rallies from here, GDX’s breakout will likely be to the upside. If gold drifts, so will GDX. And if gold resumes selling off in its own truncated correction, GDX will follow it lower.

Like the major gold stocks, gold’s rallies relative to the scary geopolitical news so far this year have been anemic. Again in late January gold was merely 2.1% higher than its last upleg’s original peak back in early September. Its total gains were less than $33 in 4.9 months. That’s pathetic given the US-Iran military attacks and pestilence ravaging China. These shocks should’ve blasted gold hundreds of dollars higher!

Yet gold has only mustered a lethargic reaction at best. It isn’t attracting the kinds of capital inflows that it ought to be given the ominous news flow. And that’s almost certainly why gold stocks failed to amplify its gains. Seasoned gold-stock traders closely watch gold, and they’re well aware gold’s upside has proven weak relative to this situation. So they’ve prudently held off on buying gold stocks until this oddness passes.

The two primary drivers of gold’s own price action are speculators’ gold-futures trading and investment buying. I’ve written much about both in recent months. Specs have mostly been all-in gold futures since early September, their capital firepower for buying more largely exhausted. And investors haven’t been interested in gold with the stock markets levitating to endless new all-time highs on central-bank money printing.

As I discussed in mid-January, the recent gold buying is precarious. Speculators’ hyper-leveraged bets in gold futures can be considered in gold-bull-trading-range terms. The most-bullish-possible positioning for gold is them having 0% longs and 100% shorts relative to their own gold-bull ranges, meaning they have vast room to buy more gold futures to add to their longs and cover existing shorts. That is super-bullish for GDX.

The most-bearish-possible near-term setup for gold and its miners’ stocks is specs having 100% longs and 0% shorts. That means they have bought pretty much all the gold futures they are likely able to, and leaves vast room to sell both existing longs and add new shorts. In early September total spec longs and shorts hit 96% and 8%, which was really bearish for gold and gold stocks. That threatened major corrections.

I also wrote about this menacing gold-futures-selling overhang in mid-September. Some progress was made in normalizing specs’ excessively-bullish bets, with their positioning starting to mean revert hitting 77% longs and 8% shorts in mid-October. But that necessary and healthy rebalancing was cut short in late December, as it was speculators aggressively buying gold futures that fueled gold’s downtrend breakout.

By year-end, total spec longs and shorts were right at that most-bearish-possible read of 100% longs and 0% shorts! That’s the reason gold didn’t soar on the US-Iran conflict and China’s coronavirus outbreak. The gold-futures specs who dominate gold’s short-term price action were already fully-deployed, with little spare buying capacity. That situation persisted into late January, when specs had 97% longs and 0% shorts.

With these influential traders still having little room to buy but vast room to sell by their own gold-bull-to-date standards, there’s much-higher odds of gold selling off again than rallying materially. And as goes gold, so go the major gold stocks. GDX will amplify any significant gold moves lower on specs unwinding their excessively-bullish gold-futures bets. That would almost certainly force this ETF to fresh correction lows.

Compounding gold’s problems, gold investment demand has been weak too. Despite this year’s stunning gold-bullish developments, identifiable gold investment demand has barely budged. Its best daily proxy is found in the bullion holdings of the world’s leading GLD SPDR Gold Shares gold ETF. As of this week they still remain slightly below gold’s last-upleg-peak levels from late September. Investors aren’t buying!

The biggest reason is likely the extreme euphoria spewing off these record-high stock markets. Thanks to the Fed’s extreme QE4 Treasury monetizations, the US stock markets have rocketed higher since that campaign began in mid-October. These fast gains have fueled epic complacency, investors don’t have a care in the world. Popular expectations that stocks will keep rallying indefinitely greatly retard gold demand.

Gold is the ultimate portfolio diversifier, the go-to asset to mitigate losses during major stock selloffs. So it is largely forgotten when stock markets are surging. Gold investment demand is unlikely to resume in size again until these lofty euphoric US stock markets suffer a correction-grade 10%+ selloff. And if investors aren’t buying gold and gold-futures speculators can’t, then there’s no way it can stage an upside breakout.

On top of this bearish gold seasonals are coming into play again too. After gold’s strongest seasonal rally of the year from late October to late February, this metal tends to suffer a seasonal slump into mid-March. That headwind will likely exacerbate any gold-futures selling. Normally that pre-spring-rally slump comes after the Chinese Lunar New Year celebrations, which see major consumer gold buying for holiday gifts.

But this year China’s entire week-long Lunar New Year holiday was cancelled with that novel coronavirus out of control! The Chinese people largely couldn’t travel to see family and friends, couldn’t gather together in public to celebrate, and that probably heavily impaired normal LNY gold demand. Thus the post-LNY gold slump could come earlier than usual this year. That would drag the gold stocks lower in sympathy.

Given all this, it still looks prudent to remain cautious on gold stocks here. Their high consolidation since early September hasn’t yet finished their necessary corrective work. And their dominant primary driver gold faces massive mean-reversion selling in gold futures while investors are distracted by these euphoric record-high stock markets. Couple that with weak seasonals, and gold is more likely to retreat than rally.

So gold-stock traders ought to remain patient here. If gold falls 10% from its late-January peak, the major gold stocks could drop 20% to 30% given their usual 2x to 3x leverage. But even if they only retreat 15%, that will still yield way-superior entry points to redeploy capital for this sector’s next major upleg. It should be well worth the wait. This gold bull’s prior three GDX uplegs averaged mighty 87.3% gains over just 6.7 months!

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The bottom line is gold stocks remain stalled, making no progress on balance over the past half-year or so. Despite higher gold prices fueled by geopolitical fears, the major gold stocks are carving lower highs. Gold-stock traders are worried about gold’s anemic gains given the news, so they are wary of deploying big capital into the miners. That caution is wise given gold’s situation, with selling much more likely than buying.

The gold-futures speculators who overwhelmingly drive gold’s price action remain tapped out, their capital firepower for buying exhausted. The Fed’s extreme stock-market levitation has sapped investors’ interest in gold, while the Chinese haven’t been able to do their normal Lunar New Year buying. All that leaves gold and thus its miners’ stocks continuing to face risks for sizable selling. Wait until that runs its course to buy.

(By Adam Hamilton)