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Stealth Bottom Coming in Gold Stocks


While amateur gold bugs panic out of their positions, the real professionals are quietly accumulating the best of breed companies at a discount and accumulating select juniors at great values.

The struggle of the mining stocks has surprised many including me and my firm. We thought record profits and a bullish environment would catapult the miners out of a consolidation and into a major breakout. The perception of an enduring recovery and the endurance and persistence of the wall of worry stage has left the gold stocks unloved and underowned and for far longer than we expected.

We do have to remember that the miners exploded in 2009 and 2010, and it is normal for a bull market to spend months in consolidation. As a result, we hear calls of market manipulation and intervention and calls to abandon gold stocks and only own physical metal. We heard these calls in 2008-2009 and now we hear them again, which would only prove disastrous for those who heed such advice. The miners are not only extremely oversold, but recent price action suggests a bottoming process is beginning.

Let us start with sentiment, which is an important factor in deciphering potential bottoms. SentimenTrader has a new indicator based on put-call ratios, short-interest, and analyst expectations that evaluates the overall sentiment of a sector. As we can see, the gold stocks are presently rated as bullish from a contrarian perspective.

Another reason we are expecting a bottom is the relative strength in the leading miners. Goldcorp (GG), Barrick (ABX), and Newmont (NEM) constitute about 42% of the Amex Gold Bugs Index (^HUI) and Market Vectors Gold Miners ETF (GDX). Therefore, their status and performance carries much weight within these indexes. From the chart below, one can see that GDX printed new lows in October, December, and again last week. While the market printed new lows, Goldcorp, Barrick, and Newmont rebounded from strong support. The strong underlying support in these names bodes very well for the entire sector.

Click to enlarge

Recently, we bemoaned the poor construction and performance of the HUI and GDX, which do not replace the laggard companies soon enough. Poor operational performance of some companies is a reflection of a tough business and not gold stock fundamentals. At my firm, we solved this problem by creating our own large-cap index of the 10 largest and best-performing gold stocks. This index helped us predict a 15% decline in the market. Days ago, our index bottomed at the December 2011 low and has subsequently shown good follow-through on Friday and today.

Click to enlarge

Certainly it has been a tough few months and a tough last 12 months for gold stock investors. However, the good news is twofold. First, there are plenty of companies that have performed well and continue to perform well in this difficult environment. Second, the long-term correction and consolidation that began at the end of 2011 may be finally coming to an end. In recent months we believed a breakout was coming, but instead, the market only continued to consolidate.

Our work tells us that the market has begun a bottoming process that could occur in stealth fashion and similar to what occurred in 2005. While amateur gold bugs panic out of their positions, the real professionals are quietly accumulating the best of breed companies at a discount and accumulating select juniors at great values. The reemergence of the precious bull market will take some by surprise, but not us.

Editor's Note: See more from Jordan Roy-Byrne at The Daily Gold.
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No positions in stocks mentioned.

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