The precious-metals stocks did not take kindly to
gold’s steep selloff this week.
On Monday the flagship HUI gold-stock index plunged 6.0% at the climax
of what can only be described as a crash. In this event’s final 3 days, the
HUI bled 13.1% of its value. In
less than a month, it had plummeted 33.1% by the time the dust settled!
Although the HUI has a well-deserved reputation for extreme volatility, this selloff was still exceptional. Typically, sharp HUI declines emerge after major uplegs
from high levels. But as you’ll see in these
charts, the HUI wasn’t high technically when this heavy selling started
battering it as August dawned. In
fact it was already pretty beaten-up pre-crash,
under both its summer support and 200-day moving average.
To drive such an ugly scenario, especially off of
lows, sentiment among PM-stock traders had to be exceedingly bad. Great fear was necessary, and the
catalyst for this fear was a technical breakdown in gold sparked by a sharp
surge in the US dollar. Since
gold stocks ultimately follow gold, sellers dumped PM stocks aggressively as
they watched gold get hammered.
In the aftermath of such an extraordinary technical
and sentimental event, most PM-stock traders feel shell-shocked and
confused. Have gold stocks just weathered
such a catastrophic event that their recovery will probably be measured in
years? Or was this crash a
short-term anomaly that has led to an epic gold-stock buying opportunity?
Of course much depends on gold for the answers to
these questions. If its bull
market is over, its stocks aren’t likely to fare well as its price
gradually retreats in a bear. But
if this gold bull is alive and well, then gold stocks will probably recover
rapidly. While it’s beyond
the scope of this essay to discuss gold’s fundamentals in depth, I
suspect the latter is the case.
It takes a lot more than a speculative dollar surge to end a secular
gold bull!
Global demand for gold, especially on the investment
side, continues to grow. We live
in a fragile era of economic disruption and rapidly inflating currencies
which makes gold increasingly attractive for investors worldwide. Diversifying a fraction of one’s
capital into gold is almost always a very prudent investment strategy. Meanwhile global gold-mining output is
actually declining despite very
favorable price levels compared to history.
Gold is very challenging to mine which severely
limits its mined-supply growth.
It is unbelievably difficult and takes many years to explore for and
find this elusive metal, secure permits and financing, sink mines, and bring
new supplies to market. With
global demand growth outpacing global supply growth, this gold bull remains
healthy and should continue climbing higher on balance for years to come.
On top of these gold-specific bullish fundamentals,
fiat-currency growth rates (say 7% to 8% annually on average globally) are
several times greater than the growth rate of the world’s above-ground
gold supply (under 2%). Thus it
is inevitable that relatively more units of any paper currency will be
competing for relatively fewer ounces of gold. This fact alone ensures gold’s
bull will continue for many years to come.
So if gold’s fundamentals still look bullish
to you, then gold stocks are all but certain to follow their metal higher. Higher gold prices ultimately lead to
bigger profits for mining this metal, lower valuations
for gold stocks, and more investment demand chasing these companies to
participate in their big profits.
This is my own worldview today, so this essay is written from the
perspective of gold’s bull being very much alive and well.
And if gold’s secular bull does indeed
continue its resolute march heavenwards, then odds are we just witnessed one
of the greatest PM-stock buying opportunities of this entire bull. The following charts highlight just
how extraordinary this selloff was, how incredibly deeply oversold the HUI
plummeted, and what a blessing it is for buyers to be presented with such low
fire-sale prices deep within a powerful secular bull.
This first chart offers a short-term technical overview
to provide perspective for the more important long-term charts below. From August 2007 to March 2008, the
HUI was powering higher in a modest 71.5% upleg
that carried it to all-time highs. It then corrected sharply, driven by a
plunging gold price sparked by the Federal Reserve’s
“restraint” in not cutting US interest rates by 100 basis points
on March 18th.
By late April the HUI had fallen 24.4%, but then it
started gradually climbing higher again in its usual summer
consolidation. By mid-July the PM
stocks had rallied 20.6% and were near the top of their summer-doldrums
trading range. Not surprisingly
they started correcting around summer resistance, and within a couple weeks
the HUI was back down to its summer support in late July. Everything was normal to this point.
But then unfortunately gold, also very low in its
own summer range, took a big hit on a surprise dollar rally. The US dollar rocketed to its biggest
daily gain against the euro since September 2000 on Friday the 8th after the
ECB president said the weak European economy meant further rate hikes were
unlikely. This led to an
unfortunate chain of technical and sentimental events, described in this
week’s Zeal Speculator,
that drove gold well under its own support.
On this chart, most of the crash from 400 or so on
the HUI in late July to this week’s appalling 314 low is the direct
result of this dollar-spike-driven gold plunge. Sequential technical failures in gold
sparked a devastating panic among PM-stock traders who raced for the exits. The result was a HUI close just 4.6%
above August 2007’s HUI low despite gold running 25.0% higher over this
same low-to-low time frame.
Understandably such utterly dismal PM-stock levels
drove much wailing and gnashing of teeth. To see the HUI languishing near 315
while gold was running around $825 was incredibly demoralizing. The HUI first hit such levels back in
January 2006 while gold only traded around $560! It took fast and furious selling this
week, with few offsetting buyers, to drive PM-stock prices back down to such
bygone levels.
Now I have to digress into market psychology
here. Just because the HUI hit
314 this week doesn’t mean it is a valid appraisal of PM-stock
prices. Extreme greed or fear can
sometimes drive stock prices far above or far below where they would normally
trade. And sentiment among
PM-stock traders was definitely exceedingly bad, dripping with fear. But just as a beach ball held under
water will spring to the surface once you release your hands, stock prices
driven too low by fear will roar back as soon as that fear abates.
Legendary investor Benjamin Graham’s favorite
allegory humanized this phenomenon as Mr. Market. Mr. Market is a manic depressive. Sometimes he is very happy and high on
stocks and only offers them to you at expensive prices. Other times he is deeply morose and
depressed and readily willing to depart with his stocks for very cheap
prices. Mr. Market is often very
irrational and his most severe mood swings can drive serious short-term price
anomalies.
Graham’s key point was that investors
shouldn’t misinterpret Mr. Market’s radical mood swings as
representing the true value of the stocks they hold. Excessively skewed sentiment will soon
pass. A strange confluence of
one-time events led to this week’s deeply oversold HUI. The dollar rallied sharply out of the
blue right when gold was at a critical technical point. Gold broke down and PM-stock traders
panicked. This all happened late
in the summer doldrums
when PM sentiment was already poor.
With PM-stock traders already spooked at best,
selling quickly snowballed.
Gold’s breakdown scared some traders, compelling them to
sell. The falling stock prices
driven by these guys soon drove rational traders’ stocks down to their
stops too, putting more shares on the market and igniting a vicious
circle. With few buyers around,
in a usually low-volume span of time, prices had to fall sharply before
PM-stock buy-side demand and sell-side supply finally equalized.
So while the technical damage in PM stocks was
indeed severe, it was driven by unsustainably frightened sentiment. Prices can only remain deeply oversold
as long as the fear that drove them there persists. But the markets abhor sentiment
extremes so they never last for long.
The same traders who sold aggressively this week will soon be buying
back in once they realize the sky isn’t falling.
These next two charts show just how extreme the HUI
fear was relative to the history of this bull. As all contrarian investors and
speculators know, the greater the popular fear the better the time to add new
long positions. This latest
irrational selloff in the PM stocks drove them down to levels not seen in a
year despite gold being far higher now than it was the last time these levels
were witnessed. If gold’s
bull remains intact, this week was one of the most epic buying opportunities
of this entire PM-stock bull.
My Relativity trading theory
applied to the HUI offers a great read on prevailing PM-stock sentiment. It simply takes the HUI and divides it
by its own 200-day moving average on an ongoing basis. The resulting multiple forms a
horizontal trading range. High
rHUI points represent extreme greed and low rHUI points represent extreme
fear. The greater the numerical
extreme, the more intense and unsustainable the emotion driving it.
Note above that the rHUI low driven by this
week’s selloff was the lowest of
this entire bull! Relative to
its 200dma, the HUI has never been cheaper! This extreme oversoldness is
absolutely unsustainable. How do
I know? Check out the HUI’s
actions after previous rHUI lows.
They never persisted for long since the sheer levels of fear necessary
to hold the HUI this far underwater cannot last. Neither will today’s.
Interestingly the secular rHUI support line had
actually been gradually rising until this latest selloff. Fear extremes were becoming less
intense as this gold-stock bull matured.
This makes sense. The
longer any bull runs, the more true believers it creates. These true believers aren’t weak
hands that are easily scared in any selloff. Despite this trend, rHUI support
failed as our recent selloff was exceptional in its intensity.
Per Relativity trading theory, which has been very
successful in trading this PM-stock bull, the HUI has never been more
oversold than it was this week.
This stunning development really buttresses the case that we just
witnessed an epic once-in-a-bull buying op in irrationally beaten-down PM
stocks. So if you have been
looking forward to deploying capital in this sector ahead of the usual autumn gold rally,
rejoice!
Before we move on, there are some interesting
technicals readily apparent at this long-term scale that aren’t obvious
on short-term charts. First,
check out the broken head-and-shoulders technical price formation in the
HUI. Late in 2007 the HUI formed
a left shoulder, then it surged higher to a head in early 2008. And then in mid-July the right
shoulder formed. The neckline ran
between 380 and 385 or so.
This H&S failure spawned major fear among
long-term technically-oriented traders.
When its neckline failed on the third trading day in August, that
event called for a sharp decline in prices. Of course this pattern isn’t
always proven right, but countless traders watch for it so it can become a
self-fulfilling prophecy. If
enough traders act on any technical signal, their collective trading can
actually transform it into market reality.
Second, this week the HUI bounced at an old support
line that goes back to early 2006.
This support now intersects a major basing zone established when the
HUI consolidated between mid-2006 and mid-2007. So chances are there are tons of
strong hands within 30 points on either side of 330. The HUI’s huge year-long base in
this range also argues that further sharp PM-stock selloffs are highly
unlikely from here.
Another way to measure how overbought or oversold gold
stocks are, and hence how much greed or fear is present, is to look at the
HUI compared to gold. The
HUI/Gold Ratio simply divides these two and the resulting multiple shows
relative strength. When this
ratio is rising, the HUI is outperforming gold. When this ratio is falling, gold is
outperforming the HUI. This week incredible HGR extremes
were also hit.
Prior to 2008, the HGR was climbing higher in the
secular uptrend defined above.
This started to fail earlier this year when the gold stocks failed to adequately leverage
the underlying gains in gold. But
this ongoing HGR secular support failure really became decisive this
week. Since the HUI plummeted far
faster than gold, gold effectively outperformed it which drove the HGR down
to extremely oversold levels.
In fact, this week the HGR fell to its lowest levels
witnessed since mid-2003! It has been over 5 years since the
markets valued PM stocks so cheaply relative to the gold price. But like any other fear proxy that
measures oversoldness, extreme HGR lows never persist. Look at past sharp HGR declines to
deep lows in this chart. They
never lasted for long because the HUI inevitably rallied sharply out of these
dismal lows. Abnormal fear never
persists, and big rallies emerge out of it once this fear abates.
Thanks to the HGR’s poor performance in 2008,
some traders including me are wondering if its old secular uptrend is
obsolete. For example, it could
now be in a giant horizontal range
between 0.40 and 0.60 or so. Even
in this unfavorable scenario (compared to the secular HGR uptrend), the HUI
could still rally sharply. To go
from a 0.40 HGR to 0.60, the HUI would have to rally 50% if the gold price
merely remained constant. But
odds are gold will rise, meaning the HUI will rally by far more to maintain
this potential HGR range.
As the rHUI and HGR show, by virtually any measure
the HUI was just hammered to the most extreme oversold lows it has witnessed
in many years or this entire
bull. The raw levels of fear
necessary to drive multi-year extremes are staggering and never
sustainable. As this irrational
and intense fear dissipates, the HUI will rise until PM stocks more fairly
reflect their long-term fundamentals in today’s higher-gold-price
environment.
And all this assumes gold is just flat, that it can
merely sustain these levels. But
odds are it is due for a major upleg in the coming months! I explained why last week in my latest
essay on gold seasonals. A fascinating variety of cultural
customs all converge in autumn to drive big increases in gold demand across
all the world’s largest gold consumers. Gold is traditionally very strong
between August and February.
And if gold rallies this autumn as usual, the case
for the HUI looks all the more bullish.
Today’s PM-stock buying opportunity looks epic even if gold
stays flat. It is hard or
impossible to find more deeply oversold levels than we saw earlier this
week. But the higher gold
meanders, the more anomalous today’s PM-stock prices look. If gold starts climbing rapidly, and
PM-stock traders quickly grow greedy, the resulting HUI rally could be truly
explosive. The deeper the
pre-rally lows, the more potential the rally offers.
At Zeal we’ve been preparing for early August
seasonal lows in PM stocks for some time. We mostly sat out the summer doldrums,
just trading GLD calls to ride the summer range. But in the last couple weeks
we’ve started layering in new PM trades for the probable autumn gold
rally. If you want to join us, please subscribe today
to our acclaimed monthly or weekly
newsletters. In the latter we picked up some incredible blue-chip PM-stock bargains
just this week. And we will be
buying more soon.
The bottom line is PM stocks hit incredibly oversold
levels this week, their most extreme in many years or for this entire
bull. It took exceptional fear to
drive so much selling, and the catalyst that sparked this fear was a strange
confluence of one-time events.
Now that the huge daily dollar spike and resulting gold breakdown are
behind us, the fear should rapidly abate and PM stocks will seek more rational
price levels.
If the underlying gold bull driving the PM-stock
bull remains alive and well, the buying opportunity in PM stocks today is
nothing short of epic. And all
signs indeed point to a continuing climb higher by the price of gold. Global supply and demand fundamentals
for the metal remain very bullish while fiat-paper currencies are expanded by
central banks at frightening rates.
PM-stock buyers
should rejoice!
Adam Hamilton, CPA
Zealllc.com
August 15, 2008
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