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Gold and Silver Stocks: A Dramatic Change in Fundamentals or a Short-Term Anomaly?

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Miners can be quite volatile on a short-term basis. Expect to see similar volatility when the rally resumes.

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The stock exchange is a very volatile, emotion-driven place. Even though most of the time one can predict future moves in particular assets with decent effectiveness, every once in a while abrupt and unexpected market moves take place. And we have just seen such violent and heavy declines in precious metals mining stocks.

Sadly, no one is able to foresee the future with 100% certainty and this is why diversification is such a crucial concept in investing. It would have certainly protected gold and silver investors' profits or at least diminished their losses had they invested not only in mining stocks but also in metals themselves.

Now, the following question arises: Is this a sign of some important change in the mining stocks sector or just a short-term anomaly? Let's take a look at the charts to find out – we'll start with the miners to gold ratio (charts courtesy of http://stockcharts.com).



On the above chart, we see that the ratio plunged this week. This is seen every few months and is almost always followed by an immediate reversal and a rally in prices. This can be seen in August 2011, October 2011, and January 2012. Very sharp declines are followed by strong rallies, and this is also seen in early July 2012. This was actually the final buying opportunity before a strong rally emerged in gold prices. At that time, the RSI was extremely oversold, and this is the case today as well. Although it may be difficult to believe, the situation is still bullish in this chart.

Now, let us move on to junior mining stocks.



In the Toronto Stock Exchange Venture Index (which is a proxy for the junior miners as so many of them are included in it), we see a move below the horizontal support line. This move was sharp, sudden and has not been confirmed. We expect to see an invalidation of the move in the coming week. Since this breakdown was not confirmed, the situation has become only slightly more bearish this week. Not much weight is placed on this signal given the situation in the rest of the precious metals sector.

Finally, let's have a look at gold senior mining stocks.



In this week's medium-term HUI Index (INDEXNYSEGIS:HUI) chart, we see that the index has moved to a combination of support levels. The plunge was dramatic and took the RSI to 30. This had not been seen since the final 2012 decline bottom. Prior to this, it had only been seen a few times. With the situation extremely oversold from a technical perspective, a sharp pullback is likely here.

We would like to reiterate what we wrote at the beginning of today's essay: This week's declines are an excellent example of a need for diversification in trading, even though the precious metals sector is closely correlated in most cases. We recently suggested buying gold, silver and mining stocks when gold was at its 300-day moving average. Gold and silver positions are now profitable and mining stocks ones are not due to this week's decline.

Please keep this in mind for future trades: Remember that using signals from various sources can protect you from most of the anomalies of this kind. Yes, we believe that this week's action in mining stocks should be called an anomaly. Although the miners follow stocks (in case you believe this decline could have been predicted by looking at stocks' decline), please note that so does silver in many cases due to its multiple industrial uses. This week, we saw declines in the miners along with stocks but not in silver prices. In the last few days, the miners declined heavily and silver not at all. While we can't be prepared for each single outcome because there are too many of them, you can really limit the risk and your exposure to such anomalies through diversification. One way to follow this principle is to take positions in many parts of the precious metals market, another one is to diversify between strategies (gold trading vs. gold investment) and there's also one that is based on diversifying sources of signals.

Summing up: The decline seen in the mining stocks was very dramatic. This was virtually the only part of the sector that looked so bearish. Miners can be quite volatile on a short-term basis and we expect to see similar volatility when the rally resumes. We view the current performance of miners as an anomaly that will soon disappear when metals continue their upswing.

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.

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