After India’s
central bank gobbled up half of the gold (200 metric tons) the IMF recently
offered for sale, gold surged 2.4% on Tuesday to a new all-time nominal high near $1085.
Naturally traders flooded into the gold stocks to leverage such an
exciting day, driving the flagship HUI gold-stock index up by 8.0%.
Although this surge was certainly fun, considered in context its
results were disappointing.
Believe it or not, in the hyper-volatile HUI an 8% up day isn’t
very rare. There was a 9%+ one in
early September and a 7% one in early October. Considering gold rallied $25 in a
single day and exceeded its old record by $21, the HUI ought to have done
much better on Tuesday.
Even more disturbing though was the HUI’s closing level that
day, just 426. In this post-panic
environment, the HUI was at this same 426 back in mid-September when gold was
only at $1006. Seeing the HUI
dead flat over a 7-week period where gold soared 7.9% reveals dreadfully poor
performance. And back in October
2007 when the HUI originally hit 426, gold was only trading at $791! Gold stocks have really lagged.
Of course the stock panic explains this long-term disconnect, as
precious-metals stocks are still recovering from their brutal panic beating.
Eventually they will fully
reflect today’s much-higher prevailing gold prices. And it is echoes from this panic that
are driving the short-term disconnect over recent months. Investors and speculators must realize
that gold is no longer the sole driver of PM-stock price action.
Ultimately from a long-term fundamental perspective, the gold price is all that matters for gold
stocks. The higher the gold
price, the fatter this industry’s profits grow for mining this increasingly rare metal.
And over the long term in the stock markets, higher profits always
translate into higher stock prices.
But over the short term, traders often choose to ignore fundamentals
and instead trade on emotions.
When greed and fear are controlling trading decisions, gold-driven
fundamentals take a back seat to prevailing sentiment. And all kinds of things affect
sentiment, including gold. This
is why the HUI’s surge on Tuesday amplified gold’s own by
3.4x. But more often than not in
this past year, gold has not been the dominating ingredient in the
HUI’s sentiment mix. This
has really frustrated traders.
Eclipsing gold time and again lately, the general stock markets have often been the overshadowing
influencer of PM-stock sentiment.
When general stocks are doing well, PM-stock traders feel good and are
more willing to buy. But
unfortunately this relationship is asymmetrical, far more potent to the fear
side. When general stocks start
sliding, PM-stock traders’ fears multiply rapidly leading them to
aggressively dump their PM stocks.
Traders who understand the general stocks’ sometimes
overpowering influence over gold stocks are thriving in this post-panic
environment. But traders still
mired in the old only-gold-matters paradigm are really struggling. If you start considering tactical HUI
moves in terms of not only gold action but general stocks’ influence on
prevailing sentiment, everything becomes much clearer and frustration
vanishes.
The quickest way to reach this mindset is to consider the HUI’s
performance in the context of the general stock markets’ performance
this year. The definitive proxy
for the latter is the broad S&P 500 stock index (SPX). And since it is the SPX’s
periodic pullbacks that are really wreaking havoc in the gold-stock world, we
need to focus on them. The mild
fear they spawn has really had a disproportional impact on the HUI.
The following chart overlays 2009’s HUI price action (blue) on
top of the SPX price action (red).
Then these indexes’ performances are compared during SPX pullbacks. These SPX pullback spans are the same
ones I defined a couple weeks ago in an essay on the then-coming overdue SPX pullback. In
addition to the HUI and SPX performances over these SPX-pullback spans, I
included those of gold and silver for reference.
Before we dive into the particulars of the SPX’s outsized
influence on the PM stocks, it is crucial to keep the strategic context in
mind. Since its early-March
despair-driven low, the SPX has entered a new cyclical bull market.
Mid-upleg pullbacks to rebalance sentiment are natural and healthy
within all bulls, no matter how powerful. But today with traders still on edge
thanks to the panic, the SPX’s pullbacks poison sentiment universally. When this SPX bull wavers, even
unrelated markets get nervous.
And the HUI is enjoying a powerful bull-market upleg of its own,
trending steeply higher within the well-defined uptrend channel rendered
above. So realize that the SPX
action’s influence on PM-stock-trader sentiment is operating within the
bounds of this trend channel. SPX
pullbacks are not really a threat to this strong HUI upleg, but more of a
thorn in the side of PM-stock traders who haven’t studied them.
Interestingly, since the March 9th SPX low the HUI has had a strong
positive correlation with gold.
It yields an r-square of 86%, indicating that 86% of the HUI’s
daily price action is statistically explainable by gold’s own. But provocatively over this very same
span, the HUI also had a similarly-strong positive correlation with the
SPX. The HUI/SPX r-square ran
76%, nearly as intense as the HUI/gold one. Statistically, the SPX has almost
influenced the HUI’s day-to-day performance as much as gold!
Diverging briefly here, there is a common factor explaining why the
SPX, gold, and the HUI have all been so highly correlated. It is the US Dollar Index. During last year’s stock panic,
traders fled the stock markets and flooded into US dollars and short-term
Treasuries. Echoes of this panic
trade still persist today, as the dollar tends to be strong when stocks are
weak and vice versa. And of
course the dollar’s performance helps drive gold futures, leading to
the SPX effectively driving gold via the intermediary of the US dollar.
So far since the March 2009 lows, there have been 8 pullbacks in the
SPX. Today’s is the eighth,
which I suspect has yet to fully run its course. If you consider how the HUI has
performed during the exact spans of these 8 SPX pullbacks, it will clarify
much. Without exception, this
year’s frustrating periods where the HUI has underperformed gold are
directly explainable by SPX weakness.
General-stock sentiment splash damage has been spilling over into PM
stocks.
The SPX fell 5.4% during its first pullback in late March. This was a quick 2-day pullback, and
gold itself was also weak with a 1.9% loss. So naturally the HUI slumped too, down
4.7%. This loss was a little
larger than gold’s own warranted though. As a general rule of thumb, the HUI
tends to leverage gold by about 2 to 1 over any short span of time. So the SPX dragged it lower than the
3.8% that gold had justified.
The SPX’s second pullback in mid-April was very fast, 4.3% over
a single trading day.
Interestingly the HUI bucked the trend here, surging 4.0% that day on
a large 1.7% gain in gold. This
helped define a rather important exception to this SPX-pullback-and-HUI
relationship. When gold rallies
big and gets PM-stock traders excited, the positive sentiment sparked by the
gold surge can outshine the negative sentiment spawned by the SPX slump.
The SPX’s third pullback ran 5.0% over 5 trading days in
May. But over this span gold was
strong, up 1.7%. Given
gold’s strength, conventional PM-stock analysis would have expected
3.4% gains in the HUI (2x leverage to gold). But provocatively the HUI slumped
0.4%, effectively splitting the difference between the SPX’s losses and
gold’s gains. At the time,
I told our subscribers about this critical clue warning that the HUI was torn
between serving two masters. Gold
was no longer its only concern.
The SPX’s last meaningful pullback (fourth), its only
significant one of this upleg until today’s, dragged this elite stock
index down 7.1% over 19 trading days in June and July. Gold weathered this weakness
impressively well, only sliding 2.8%.
But the poor HUI didn’t prove as resilient, falling 10.2% (3.6x
downside leverage to gold). And
silver, a volatile commodity as affected by general sentiment as gold stocks,
plunged 14.6%. Clearly SPX
weakness was poisoning sentiment among PM-stock traders.
The SPX’s fifth pullback in mid-August was much milder at 3.3%
over 2 days. Gold, also pretty
correlated with the SPX especially during pullbacks, fell 2.2% too. With both of its major drivers weak,
the nervous HUI was really hit disproportionately hard. It plunged 7.3% (3.3x leverage). With gold in the $940s, this PM-stock
weakness was very frustrating for traders. Gold remained very high in historical
terms, yet gold stocks were still being sold aggressively.
The SPX’s sixth pullback straddling the August/September border
reignited that exception where very positive sentiment generated by a gold
surge can drown out weak sentiment generated by an SPX slump. The SPX fell 3.5% over this
4-trading-day span, yet the HUI surged 6.7% higher on a 3.2% gold rally. But before the sharp 2.4% gold rally
of September 2nd (same percentage gain as this Tuesday’s), the HUI was down 3.8% in the preceding 2
days. Thus the HUI rocketing 9.3%
higher on the third day masks its weak mid-SPX-pullback internals that
existed for most of this sixth pullback.
Nevertheless, I’m thankful to know that when push comes to
shove, even over the short term, gold still wins out in the hearts and minds
of today’s PM-stock traders.
They will respond favorably to fast-rallying gold prices almost no
matter what the SPX is doing. It
is only when gold is flat or weak that spillover SPX fear really taints PM
traders’ sentiment.
The SPX’s seventh pullback erupted in late September, witnessing
a 4.3% loss over 8 days. And yet
again the HUI was hit hard by the SPX weakness’s impact on universal
sentiment, falling 7.7%.
Meanwhile the gold price was only down by 1.2%, so it certainly
didn’t justify the HUI’s considerable retreat. Thanks to the SPX’s
sentiment-poisoning impact, the HUI leveraged gold’s decline by
6.4x. This is no big deal if
traders are psychologically prepared for it, but if they are caught unaware
it is very discouraging.
Finally the SPX’s eighth pullback began in mid-October in the
heart of a dazzlingly-bullish Q3 earnings season. While I doubt today’s pullback
is over yet, as of last Friday it had sliced 5.6% off the SPX over 9 trading
days. Once again gold proved
impressively resilient, only retreating 1.7%. Yet the excitable HUI was just crushed,
down 12.9% over this short span of time.
This 7.6x downside leverage to gold, the SPX splash-damage effect, was
getting pretty excessive.
On average across all 8 pullbacks, the SPX fell 4.8%. Meanwhile gold only averaged a 0.4%
decline over these spans, trivial.
Yet the HUI’s average decline across these SPX pullbacks ran
4.1%. Put into leverage-to-gold
terms, this is 10.3x downside leverage!
There is simply no doubt at all that the fear spawned by SPX pullbacks
is spooking PM-stock traders, leading them to sell unless gold is surging.
This revelation has important practical implications for PM-stock
investors and speculators today.
First, next time the HUI is underperforming gold, look to the SPX for
answers. If the general stock
markets are weak, the PM stocks will follow them down unless gold is surging
up so fast that PM-stock traders just can’t ignore it. This shouldn’t frustrate us
though, as the HUI’s 2009 upleg has still been steep, well-defined, and
very profitable despite the periodic bleed-through of SPX sentiment.
Second, if you are trying to time short-term PM-stock purchases
(either for long-term investment or short-term trades), pay close attention
to the SPX. If the general stock
markets are very overbought, full of complacency and greed, then they are
probably due for another pullback.
Rather than buying before the pullback and suffering the subsequent
sharp PM-stock losses, it is much more prudent to wait until the SPX pullback
matures and the PM stocks have been temporarily driven down to lower prices.
After having warned about this SPX-pullback splash damage in our
subscription newsletters for months now, I do realize this concept really
bothers fundamentally-oriented traders.
I am not thrilled with it either, as the old days (early 2000s) when
the HUI followed gold no matter what the stock markets were doing were immensely
profitable and great fun. Looking
at gold fundamentals to trade gold stocks is logical and intuitive, as
the gold price will absolutely drive their ultimate long-term fortunes.
But as traders playing the markets to earn profits, we have to adapt
to the current driving forces whether we like them (or agree with them) or
not. I’ll admit, at times
this year when the HUI fell sharply with the SPX when gold was holding strong
I was really irritated with my peers in this sector. I felt like they were acting like
pansies by ignoring high gold prices and getting scared by relatively minor
SPX weakness.
But in trading, all emotions
are destructive. Getting
irritated or frustrated because something is not working the way it used to
be or the way it should be is as damaging as getting caught up in popular
greed or fear. Ultimately what is
driving prices is irrelevant, all that matters is that we recognize those
drivers early enough so we can capitalize on them with profitable
trades. And for now, the
SPX’s spillover impact on universal sentiment is nearly as important to
PM-stock fortunes as the price of gold itself.
At Zeal we are constantly studying the perpetually-changing markets
looking for the drivers wielding the most influence today. And as soon as we identify them in the
raw data, we analyze and explain these relationships to our subscribers and
start actively trading on them.
Because of this research, we’ve been able to buy PM stocks cheap
in January, February, March, June, and July. And we sold some at big gains and
avoided buying more in May, September, and October when they were too
expensive.
While our open PM-stock trades in our latest monthly and weekly subscription newsletters had average unrealized gains of 47% and 77%
respectively, we’ve been eagerly anticipating buying more. But given that a meaningful SPX
pullback was overdue (we are probably in it now), we wanted to wait for
better prices in the near future.
Join us if you want to capitalize on the rapidly-approaching
SPX-driven buying opportunities in elite precious-metals stocks. Subscribe today and become an informed investor!
The bottom line is since the panic gold is no longer the sole
important driver of PM stocks.
The fortunes of the general stock markets, particularly when pullbacks
spark fear, have become nearly as important as gold. While SPX action is meaningless
fundamentally for gold stocks, it still really influences universal
sentiment. Falling general stocks
frighten PM-stock traders who in turn start dumping their PM stocks.
So whenever a disconnect arises between the gold-stock prices and the
gold price, consider what the SPX happens to be doing. Odds are its weakness will readily
explain any HUI underperformance relative to gold. And while there is no doubt that gold
stocks’ ultimate long-term gains will be driven by gold’s
fortunes, paying attention to other factors influencing near-term sentiment
can greatly improve trading gains.
Adam Hamilton, CPA
Zealllc.com
November 6, 2009
Also
by Adam Hamilton
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