Back in August we wrote a
piece titled: The
Catalyst for Consolidation in the Gold Sector. We noticed that the large
cap producers had begun to outperform the rest of the sector which consists
of small producers, developers and explorers. Risk aversion, the Euro debt
crisis and a struggling stock market has contributed to the continued
underperformance of the riskier plays in a risky sector. The chart below
shows GDX (large producers), GDXJ (developers, explorers) and the ratio
between the two.
As you can see, GDX was able
to maintain its support while GDXJ broke support and made a new 52-week low.
As a result, the ratio surged in favor of GDX.
Traders and investors need to
remember that gold stocks are a risky bunch and that the non-producers are
extremely risky. Yes, the sector is in a bull market but that by itself is
not enough to drive the speculative plays higher. Until we reach the bubble
phase, the non producers will rise on their own merits and not because
"it's a bull market." Though we are likely at least two to three
years from the birth of a bubble, does it mean the non-producers will
continue to underperform in the meantime?
Hardly. Remember, the large
caps (GDX) have been in a consolidation for a year and that has a negative
effect on the speculative plays. The longer a consolidation lasts, the more
weak hands jump ship. At the start of the consolidation, the non-producers
held up better. Ultimately they are going to underperform in a weak market
and outperform in a strong market. The good news is the large caps are close
to a major breakout which is not only a catalyst for the large stocks but a
catalyst for everything else in the sector.
A breakout in GDX, as we
presume in the above chart, would certainly have a positive impact on junior
developers and junior exploration plays which have underperformed badly in
the last few months. After all, this is happened before. GDXJ performed
better in Q3 and Q4 of 2010 when GDX broke out of an eight month
consolidation. GDX also made a huge breakout in the second half of 2005 and
junior stocks surged over the next 18 months.
This time, GDX is close to a
very significant breakout as it could pull away from a one-year base as well
as the 2008 highs and on some charts, the 1980 highs. Although the
non-producers have lagged, they would ultimately find a huge bid in the
immediate aftermath of a breakout in GDX. Traders and investors need to know
when to play it safe and when to take risks. Heading into this potential
breakout, it is wise to stick with producers who are finding a bid. However,
when the breakout appears imminent, it would be wise to set your sights a bit
lower on the food chain and find the developers and explorers ready for a
major rise. If you'd like professional guidance in navigating this bull
market and finding the best performing stocks, then we invite you to learn more about our service.
Good Luck!
