A Bottom may be Forming in the Precious Metals Sector

HUI: SPX Ratio 

The chart below shows the HUI: SPX ratio, where HUI is the Amex Gold Bugs Index 14 major gold-producing companies, and the SPX represents the S&P 500 stock market index. The price of gold is shown by the black line, with the data recorded from the year 2000. 

The only time mining stocks have been cheaper relative to the stock market was in late 2000, when the secular precious metals bull market was emerging. Since late 2015, when the ratio fell to its current level, the mining stocks and precious metals have been in an uptrend, albeit with a high degree of volatility.

What also stands out in the chart is that the spread between the price of gold and the HUI: SPX ratio is considerably wider now than it has been at any time going back to at least 2000. For me, this suggests that not only might a bottom be forming, but any move higher has a strong possibility of sustainability.

A Bottom in the Gold Market? 

The rallies in the sector since late 2015 have been relatively short in duration – six months in 2016 and twenty-two months from late 2018 to August 2020. By “sustainability,” I mean a bull move that lasts at least three years, like the ones from 2001-2004, 2005-2008 and 2008 to 2011.

I’ve received many emails on the question of whether people should be selling, hedging or holding at the moment. I have been struggling with that dilemma ever since I sold a big position in NUGT puts. Direxion Daily Gold Miners Index Bull 2X Shares (NUGT) is a leveraged exchange-traded fund (ETF), I was using to hedge at the end of April. While I regret not keeping the hedge in place with 20/20 hindsight, the current decline in the sector is reaching historic extremes.

Sell or Hold? That is the Question

As for whether or not to sell at this point. I’m going to hold. I’ve survived sell-offs like this in the summers of 2006 and 2008 plus the sell-off in late 2018. I would be shocked if the sector is entering an extended decline like the one that occurred from last 2011 to the end of 2015.

One reason, aside from the glaring strength of the fundamentals that support much higher prices in the precious metals sector, is that there has not yet been a frenzied, parabolic, high-volume price-chasing move higher. The best example of that is the run-up in the entire sector that occurred in late 2010 and into the spring of 2011.

Indicators of Metals Sector Bottoming

I’m starting to see several indicators that have been present in the past when the precious metals sector is bottoming. Both gold and the mining stocks (Amex Gold Bugs Index) are as extremely cheap/oversold relative to the S&P 500 as at any time going back to 2001 when the precious metals bull was beginning.

Second, the hedge funds per the weekly Comex Commitment of Traders report are now net short both paper silver and gold (the gross short position exceeds the gross long position). It’s rare when the hedge funds go net short Comex gold futures. The banks are net long silver contracts and they are aggressively covering their gross gold short position. Historically, this positioning in Comex gold and silver futures between the banks and the hedge funds has often preceded big moves higher in the entire precious metals sector.

Finally, Newmont Mining (NEM) after its post-earnings blood-bath in the stock market on July 25th is at its most oversold technically going back to 1987 (the Dow plunged 25% in October 1987).  This is another indicator that the sector may be bottoming.

Precious Metals & Stock Market Divergence

This is not to say that gold, silver and mining stocks will not go lower from here. Anything can happen if the stock market falls off of a cliff, the risk of which is quite high currently. However, I believe that most of the potential sellers are now sold out of their long positions in the mining stocks. Furthermore, in addition to being short gold and silver futures contracts, the hedge funds are also likely shorting mining stocks via GDX. In any indication of rally in the sector, the hedge funds will quickly cover their short positions and go long.

It’s my strong conviction that ultimately, whether or not the stock market has a considerable amount of additional downside – and I believe it does – at some point the precious metals sector will diverge positively from the rest of the stock market and head eventually to new all-time highs. See November 2008 to March 2011 for an example of this occurrence.

Dave Kranzler is a hedge fund manager, precious metals analyst, and author. After years of trading expertise build-up on Wall Street, Dave now co-manages a Denver-based, precious metals and mining stock investment fund.

This publication is for informational purposes only and is not intended to be a solicitation, offering or recommendation of any security, commodity, derivative, investment management service or advisory service and is not commodity trading advice. This publication does not intend to provide investment, tax or legal advice on either a general or specific basis. The views expressed in this article are those held by Dave Kranzler and not Kinesis.