Will Gold Mining Stocks Drop Any Further?

By Przemyslaw Radomski, CFA  JUN 26, 2013 10:30 AM

The outlook for mining stocks remains bearish, and the correction is likely still not over.

 


Last week was very disappointing for those who had previously been long precious metals, and it was very profitable for precious metals bears. A lot happened after the FOMC meeting and the Federal Reserve Chairman’s statement on June 19, 2013.
 
As expected, the confirmation of the Fed's intention to withdraw from QE3 clearly helped the US dollar. After about three weeks of currency declines, last week brought the breakout and a start of a rally.
 
The strengthening of the US dollar was a strong blow not only to the currencies, but also to commodity markets.
 
After Ben Bernanke’s comments, pessimism transpired to the precious metals markets, and we saw some of the biggest swings in this sector.
 
The sell-off in precious metals pushed gold and silver to lower levels; last week they hit new 2013 lows, but it seems that they haven’t found the bottom quite yet. On Friday, gold fell below its technical support around $1,285-1,308 per ounce. The decrease in the yellow metal triggered a plunge in silver. The white metal has been beaten in the recent months even worse than gold, and on Friday morning, its price accordingly went down to the lowest level since September 2010.

Could these events trigger a more profound correction in mining stocks?

It’s said that a picture is worth a thousand words. So let’s take a look at some charts below and try to come up with a thousand words to describe what we see. (Charts courtesy of http://stockcharts.com.)
 
First, I think it would be interesting to revisit the silver-to-gold ratio to see how the two are valued relative to each other. Perhaps this will provide some clues.
 

Click to enlarge
 
When you take a look at this chart, you can ask a simple question: Is the bottom already in? Several weeks ago, I mentioned the silver-gold ratio as one of the key things to look at when making the call:
 
I have previously discussed how the final bottom for the white metal is often preceded by a big underperformance of silver to gold. This is yet to be seen, so lower prices are likely still in the cards for the white metal, and the rest of the sector as well.
 
There’s been no sharp drop so far, so the bottom is likely still ahead of us. If that’s the case and the entire precious metals sector is about to move lower, how low can mining stocks go?

Let's take a look at two of the most followed commodity stock indices: the Philadelphia Gold/Silver XAU Index (INDEXNASDAQ:XAU) and the AMEX Gold Bugs HUI Index (INDEXNYSEGIS:HUI).
 

 
The XAU Index is above our initial target (84) for this decline (or at least it was at the moment of creating the above chart). As you know this target level was created from the rising support line based on the late 2000 and 2008 lows.
 
However, it seems that we could see a move even below that level and a local bottom will probably form slightly above 80. This is the range that likely needs to be reached before the declines in the mining stocks and the precious metals sector come to a close.
 
This might be a great buying opportunity or, more likely, the beginning of one.
 
Now, let’s have a look at the HUI Index. The chart below expresses a simplicity that betrays potential information on where this market may ultimately be heading.
 

Click to enlarge
 
Last week gold mining stocks continued their decline. Although investors have been selling their shares, fear remains in control. However, this may not last much longer. As mentioned above it seems that miners might move even below the initial target of 84 for the XAU Index.
 
In this case, it is the HUI Index that enables us to create a better price target.
 
There is a major support zone drawn on the chart which is a worst case scenario. The red ellipse on the above chart includes both important support levels – the 61.8% Fibonacci retracement level and the 2008 low. There’s one more thing that wasn't marked on the chart, and that is the price gap close to the 300 level (the gap was formed in April). Such a price gap sometimes indicates that at the time when its formed, the market is halfway done rallying or (in this case) declining. Taking this analogy provides us with a target in the marked area as well.
 
Our final chart today is the gold stocks-to-gold ratio, which is one of the more interesting ratios that exists in the precious metals market.
 

 
The above chart provides a very bearish picture. We see that the decline continues and that the ratio is quite far from its target – the 2000 low.
 
Please note that the trading channel and the next horizontal support intersect at a point much lower than where this ratio is today. 
 
As I wrote over a month ago on May 17, 2013:
 
The ratio has already broken below the previous late 2008 major low.... This is a major breakdown and it was confirmed. The implication is that the trend is still down.

With the trend being down and accelerating and the recent breakdown being confirmed, there is a good possibility that the miners will decline significantly once again.
 
The ratio might move to its target level -- the 2000 low -- close to the 0.135 level, which is a quite clear forecast as far as direction of the next move is concerned.

Summing up, the outlook for mining stocks remains bearish, and the correction is likely still not over.  There may be many obvious and not-so-obvious reasons for this recent underperformance of the precious metals sector, but the charts are quite clear. In my view it does not seem that the final bottom for mining stocks is in -- at least not based on last week’s closing prices.

For the full version of this essay and more, visit Sunshine Profits' website.

Twitter: @SunshineProfits
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.